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The Implementation of the European Central
Bank Project,Target2 Securities, in the European
Settlement System.
Oxana Tarasiuc
Dissertation as a partial requirement for obtaining the
Master’s degree in Information Management, with a
specialization in Risk Analysis and Management
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by
The Implementation of the European Central Bank
Project,Target2 Securities, in the European
Settlement System
Oxana Tarasiuc
Dissertation as a partial requirement for obtaining the Master’s degree
in Information Management, with a specialization in Risk Analysis and
Management
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LOMBADA MEGI
LOMBADA MGI
Título: The Implementation of the European Central Bank Project,Target2 Securities, in the European Settlement System
Subtítulo:
Oxana Tarasiuc MEGI
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Título: The Implementation of the European Central Bank Project,Target2 Securities, in the European Settlement System
Subtítulo:
Oxana Tarasiuc MGI
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NOVA Information Management School
Instituto Superior de Estatística e Gestão de Informação
Universidade Nova de Lisboa
The Implementation of the European Central Bank Project,Target2
Securities, in the European Settlement System
by
Oxana Tarasiuc
Dissertation as a partial requirement for obtaining the Master’s degree in Information Management,
with a specialization in Risk Analysis and Management
Advisor: Dr. Rui Gonçalves
February 2018
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ACKNOWLEDGEMENTS
I would like to express my deep gratitude to my thesis supervisor Dr. Rui Gonçalves, for his invaluable
help, as well as for his insightful reviewing. I am grateful to Licínio Moreira da Silva, Head of
Interbolsa and Jyrki Leppänen, Advisor to the Board of Directors, for showing their interest in my
work and contributing to my research. I would also like to express my appreciation to my family for
their patience and support throughout the whole Master program.
Thank you All!
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ABSTRACT
Post-trade market in the European Union continues to be fragmented at the national level, despite
the various legislative initiatives, as UCITS 5, CSDR, that brings more harmonization in investments.
This issue was taken in the center of focus of the Central Bank and European Commission, that
developed a successor for the Target 2 Project, called Target to Securities. With T2S, the settlement
of securities between the 17 CSDs will be done uniformized, faster and safer, all the transactions
being settled on a single pan-European platform in central bank.
It is one of the largest infrastructure projects launched by the Eurosystem so far and it brings
substantial benefits to the European post-trading industry, by revolutionizing the way securities
market works. T2S is meant to dismantle the 10 technical barriers identified by the Giovannini Group.
The costs of the implementation were shared between the participant CSDs. The future benefits are
foreseen to be great costs savings for a unit transaction, and harmonization of the flow of a cross
border transaction, like a domestic one.
KEYWORDS
T2S, securities, post-trade, Eurosystem, ECB, financial integration, settlement, clearing, risks.
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INDEX
1. Introduction ................................................................................................................ 10
1.1. Relevancy of the subject ..................................................................................... 10
1.2. Objectives ............................................................................................................ 12
2. Literature Review ....................................................................................................... 14
2.1. Risks in the Post-Trade Market ........................................................................... 14
2.1.1. Cross-Border Transaction Risk ...................................................................... 14
2.1.2. Counterparty risk .......................................................................................... 15
2.1.3. Operational risk ............................................................................................ 16
2.1.4. Legal Risk ...................................................................................................... 17
2.2. Securities Trading and Settlement ...................................................................... 17
2.3. T2S Project Implementation ................................................................................ 23
2.3.1. T2S Principles ................................................................................................ 24
2.3.2. T2S Harmonization Activities ....................................................................... 25
2.4. T2S and the New EU Regulation .......................................................................... 30
2.4.1. The Regulation on settlement and Central Securities Depositories (CSDR) 30
2.4.2. EMIR ............................................................................................................. 32
2.5. The Giovannini Barriers ....................................................................................... 32
2.5.1. The UCITS V Directive ................................................................................... 36
2.5.2. MIFID ............................................................................................................ 38
3. Methodology .............................................................................................................. 39
4. Results......................................................................................................................... 42
5. Conclusion .................................................................................................................. 53
6. Limitations and Recommendations for Future works ................................................ 56
7. Bibliography ................................................................................................................ 57
8. Annex .......................................................................................................................... 61
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TABLE OF IMAGES
IMAGE 1 SETTLEMENT BETWEEN MARKETS BEFORE T2S 11
IMAGE 2 INTEGRATED SETTLEMENT MODEL WITH T2S 11
IMAGE 3 SETTLEMENT FLOW ON A REGULATED MARKET 15
IMAGE 4 SETTLEMENT FLOW ON OTC MARKET 16
IMAGE 5 SETTLEMENT CHAIN 18
IMAGE 6 MARKET PARTICIPANTS 19
IMAGE 7 CLEARING HOUSE 21
IMAGE 8 EU FRAGMENTED MARKET INFRASTRUCTURE. SOURCE: ECB 34
IMAGE 9 THE DISTRIBUTION OF FEES BETWEEN ACTIVITIES 47
FIGURE 1 AVERAGE VALUE OF SECURITIES HELD ON ACCOUNTS WITH CENTRAL SECURITIES DEPOSITORIES (EUR
MILLIONS) ____________________________________________________________________________ 51
FIGURE 2 THE AVERAGE NUMBER OF PARTICIPANTS IN CSDS 2015 ___________________________________ 51
FIGURE 3 THE AVERAGE NUMBER OF TRANSACTIONS PROCESSED 2011-2015 __________________________ 52
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LIST OF TABELS
TABLE 1 T2S IMPLEMENTATION WAVES 24
TABLE 2 T2S DAY SCHEDULE 27
TABLE 3 T2S IMPACT FOR FUND INDUSTRY 37
TABLE 4 SETTLEMENT FEES OF A SAMPLE OF NATIONAL CSDS, IN EURO 45
TABLE 5 SETTLEMENT FEES OF CLEARSTREAM FOR SELECTED MARKETS, IN EURO 46
TABLE 6 SETTLEMENT FEES OF EUROCLEAR FOR SELECTED MARKETS, IN EURO 47
TABLE 7 OPERATING INCOME PER TRANSACTION (IN EURO) 48
TABLE 8 EVOLUTION OF VOLUMES OF TRADES BETWEEN 2006 2009. SOURCE OXERA ANALYSIS 49
TABLE 9 COST OF SERVICES PROVIDED BY CSDS, EQUITIES AND FIXED INCOME SECURITIES 49
TABLE 10 CHANGES IN THE RELATIVE COSTS OF CLEARING AND SETTLEMENT SERVICES-EQUITIES 49
TABLE 11 CHANGES IN THE RELATIVE COSTS OF CLEARING AND SETTLEMENT SERVICES-FIXED INCOME
SECURITIES 50
TABLE 12 CHANGES IN THE RELATIVE COSTS OF CROSS BORDER CLEARING AND SETTLEMENT SERVICES- TOTAL
SECURITIES. 50
TABLE 13 COMPARISON BETWEEN COSTS OF CROSS BORDER AND DOMESTIC CSDS SERVICES, TOTAL
SECURITIES. 50
TABLE 14 T2S ECB PRICELIST 55
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LIST OF ABBREVIATIONS AND ACRONYMS
AG Advisory Group
BCNs Brokers Crossing Networks
BIC Bank Identifier Code
BIS Bank for International Settlements
BME Group
BOGS Bank of Greece Securities Settlement System
CA corporate actions
CASG Corporate Actions Sub-group
CCP Central Counterparty Clearing House
CPSS Committee on Payment and Settlement Systems
CSD Central Securities Depository
CSDR Central Securities Depository Regulation
DAC Dedicated cash account numbering
DVP Delivery Versus Payment
EBA European Banking Authority
ECB Eurpean Central Bank
EEA European Economic Area
EMIR European Market Infrastructure Regulation
EOD End of Day
ERC The European Repo Council
ESAs European Supervisory Authorities
ESES Euroclear Settlement of Euronext-zone Securities
ESMA European Securities and Markets Authority
EUR EURO
HSG Harmonisation Steering Group
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ICSD International Central Securities Depository
IMF International Monetary Fund
IOC instruction owner CSD
IOSCO Technical Committee of the International Organization of Securities Commissions
ISIN International Securities Identification Number
ISO International Organization for Standardization
KDD Centralna Klirinško Depotna družba Delniška družba
MIFID Markets in Financial Instruments Directive
MIFIR Markets in Financial Investments Regulation MTF Multilateral Trading Facilities
NBB SSS National Bank of Belgium Securities Settlement System
NTS Night-time Settlement
OTC Over the Counter
OTFs Organized Trading Facilities
PFMIs Principles for financial market infrastructures
RTGS Real-time gross settlement systems
SAC Securities accounts numbering
SIs Systemic Internalizers
SOD Start of Day
SSP Single Shared Platform
STP Straight through processing
SWIFT Society for Worldwide Interbank Financial Telecommunication
T2S Target to Securities
TARGET Trans-European Automated Real-time Gross Settlement Express Transfer system
UCITS Undertakings for the Collective Investment in Transferable Securities
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1. INTRODUCTION
This thesis studies the implementation and the benefits of the new state-of-art project, Target to
Securities (hereinafter T2S), that aims to bring innovations, as cross-border openness, lower the cost
of settling transactions, economies of scale, also encouraging greater competition between CSDs,
and financial integrity in the European securities settlement industry. T2S is a technical platform,
where all trades are settled, designed to support CSDs in providing core, borderless and neutral
settlement service. T2S objectives are harmonization, maximizing safety, by reducing the risks, and
efficiency in settlement of securities transactions. Overall, it is also EU’s financial integration
objective where only one single market for settlement services is being built, with a unified, cheaper
and less risky, post-trade infrastructure. In this study we will focus particularly on the project
implementation in Portuguese Central Securities Depository, Interbolsa.
1.1. RELEVANCY OF THE SUBJECT
Despite the heightened economic significance, very little attention has been given in the debate
surrounding the new T2S infrastructure, its risks and benefits. I was inspired to dig into more details
on T2S implementation, because of its relevancy for the European financial system integration and
the actuality of the project, that up to date, finished its last migration wave on 18 September 2017.
Interbolsa was choosen, between the other 17 CSDs participants to the project, because Portugal has
already completed the migration at the moment of the research (in March 2016), and because of the
access to a broader source of information and interviews, study being held in Portugal.
Robert Schuman (1950) said that Europe will not be made all at once, or according to a single plan; it
will be built through concrete achievements. His words were revoked again by Mario Draghi,
President of the ECB, at the T2S launch celebration (in Milan, on 2 July 2015): „T2S is a central part of
the broader story of the European integration. And the path has indeed been dotted with many of
these achievements: TARGET, TARGET 2; but while these were important accomplishments, which
resulted in high level of integration on the cash side, the infrastructure supporting capital markets
continued to be highly fragmented. Europe had over 30 different systems for settling securities. The
overwhelming number of rules and approaches meant that the whole payment system and
settlement process remained convoluted and costly.”1
As shown in the image 1 below, in the Pre-T2S model, settlement and custody are market specific. EU
stock market transactions and the cross-border transactions, are marked by an unimaginable growth
in the last decades, while the post-trade arena continues to languish in silo fashion, adding
unnecessary costs. For instance, the transaction value of debt-based securities platforms (alternative
finance market segment) in Europe (excluding the UK) from 2012 to 2015 grew significantly from 0,5
million to 11 million EURO in 2015.2
1 https://www.ecb.europa.eu/press/key/date/2015/html/sp150702.en.html. Opening remarks at the
T2S launch celebration 2 https://www.statista.com/statistics/412482/europe-alternative-finance-transaction-value-debt-based-
securities/
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Image 1 Settlement between markets before T2S
The main drivers of the project, as set out by the ECB are:
• To maximize safety and efficiency in settlement of the securities transactions, by using
delivery versus payment mechanism.
• To maximize efficiency by settling cash (Target 2 Platform) and securities (Target 2 Securities)
on the same IT platform supervised by the same entity ECB.
ECB mentioned that T2S is very much in the centre of its mandate, nevertheless the project doesn’t
have a political connotation, and it is not a subsidy for a political system. T2S, together with
TARGET2, represents the main contribution currently made by the Eurosystem to the integration of
the European market infrastructure. This is the reason why, despite the financial crisis, a long-term
project like T2S with huge potential for changing European post-trading remains high on the
European agenda3. T2S strategy is a winning strategy, because its purpose is making it easier to carry
out economic activities, building a system that pulls risks sufficiently. While the Commission
recognized its role in legal harmonization, it also continued to see the integration of settlement
systems as a private-sector responsibility. Integration should be driven mainly by industry initiative
and supported by public action only where this was necessary. Such a distinction between the
appropriate roles of public and private actors was in line with the fundamental principles of the
European Union about market-based competition, in favour of an open market economy with free
competition.
Post T2S model, 2015 onwards, integrates the settlement process on a single technical platform,
while the custody remains country specific.
Market 1
Settlement
Custody
Market 2
Settlement
Custody
Market N
Settlement
Custody
SETTLEMENT
Image 2 Integrated settlement model with T2S
3 https://www.ecb.europa.eu/paym/t2s/about/multimedia/html/t2s2012.en.html
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The World Bank states that: „T2S represents a unique opportunity to dismantle Giovannini barriers
and stimulate European harmonization in post-trading. 4” It will contribute to the financial
development and organizational improvement, which makes markets more complete, increases
agents’ options when engaging in financial transactions, improves market transparency, reduces
transaction costs and increases competition. T2S is meant to revolutionize the current post-trade
landscape.
As any currency area, the euro area needs a financial market infrastructure which enables the safe
and efficient flow of payments and financial instruments. Since its creation, Eurosystem, which
comprises the European Central Bank and the national central banks of the Member States whose
currency is the euro, has one of its primary objective to safeguard financial stability and promote
European financial integration. The legal basis for the Eurosystem’s competence in the area of
payment and settlement systems is contained in Article 127(2) of the Treaty on the Functioning of
the European Union5. One of the Eurosystem’s basic tasks is "to promote the smooth operation of
payment systems" (Article 3.1 of the Statute of the European System of Central Banks and of the
European Central Bank). The first step to financial integration and globalization was the launch of
euro that has led to reshaping and harmonization of the infrastructure for euro payments and for the
trading, clearing and settlement of financial instruments. After the launch of euro, on 4 January 1999,
TARGET, Trans-European Automated Real-time Gross Settlement Express Transfer system,
commenced operations. It provided a system enabling the euro area wide real-time settlement of
euro payments, by linking together the different RTGS (Real-time gross settlement systems) that
existed at the national level. These systems allowed a considerable degree of integration in the large-
value payments segment, but in the context of EU enlargement, the system experienced various
short comes: new member states were expected to connect to the system, thereby increasing the
number of TARGET components, multiplied the local technical components, increasing the
maintenance and running costs. On 24 October 2002, the Governing Council of the ECB decided on
the principles and structure of the next-generation system: TARGET2, a real-time gross settlement
(RTGS) system owned and operated by the Eurosystem. Not like its first decentralized version, the
system was replaced by a single technical platform, the “Single Shared Platform” (SSP), provided by 3
Eurosystem central banks: Banca d’Italia, Banque de France and Deutsche Bundesbank. These
measures helped the implementation of the single monetary policy, reducing systemic risk, helped
banks to manage their euro liquidity at national and cross-border level, lead to progression in terms
of reshaping and consolidating the infrastructure in large-value payments.
1.2. OBJECTIVES
During this master thesis, the main objective is to evaluate the T2S impact on the new harmonized
European securities market landscape and also to assess its direct contribution to the reduction of
settlement costs in Europe. Talking about this objective, we target to understand the benefits T2S
brings on the table for the market participants, in particular through the case of Interbolsa Portugal.
4 http://siteresources.worldbank.org/FINANCIALSECTOR/Resources/282044-1260476242691/T2S.pdf p
15 5 http://www.lisbon-treaty.org/wcm/the-lisbon-treaty/treaty-on-the-functioning-of-the-european-
union-and-comments/part-3-union-policies-and-internal-actions/title-viii-economic-and-monetary-policy/chapter-2-monetary-policy/395-article-127.html
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Also, this research aims to describe the risks associated with the post-trade activity, the technical
inefficiencies among settlement industry in Europe, with different domestic arrangements, that T2S
is addressing. This objective relates to identifying the technical, legal and tax barriers in the post-
trade environment.
As this is a relatively new project, with no previous analogy, it is of a critical interest to prove that
there is a real harmonization of costs between European CSDs, and also that there are cost savings
per unit price of a settlement transaction, at the national and cross border level.
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2. LITERATURE REVIEW
In the following section, it will be identified the existing literature on the thesis subject, addressing
explicitly the problem of securities settlement system integration in EU and T2S initiative, that make
a significant contribution to the understanding of the T2S topic. The literature review is divided into
several sections. First, it will be identified the studies that focus on the competition and inefficiencies
in the trading system in EU, also the major risks in the settlement process. The review was further
complemented with the strands in the literature that research the microstructure and organization
of securities markets, presenting the coherent framework and performance of the stock exchange
and settlement industry and its participants. After that, it will be determined the seemingly previous
studies in the global literature concerning the integration and consolidation in payment and
securities settlement systems in the euro area.
The studies on the euro area payment and securities settlement systems are a relatively recent area
of research in finance. The main body issuing on this subject are: European Central Bank (ECB) and
the Bank for International Settlements (BIS). The first measures to address the national settlement
barriers were published in April, 2004: „The European Central Securities Depositories Association’s
Response to the Giovannini Report”. In April 2012, the Committee on Payment and Settlement
Systems (CPSS) and the Technical Committee of the International Organization of Securities
Commissions (IOSCO) published the standards report Principles for financial market
infrastructures (PFMIs). The new standards replace the three existing sets of international standards
set out in the core principles for systemically important payment systems (CPSS, (2001));
the Recommendations for securities settlement systems (CPSS-IOSCO, (2001)); and
the Recommendations for central counterparties (CPSS-IOSCO, (2004)). The CPSS and IOSCO have
strengthened and harmonized these three sets of standards, by raising minimum requirements,
providing more detailed guidance and broadening the scope of the standards to cover new risk
management areas.
2.1. RISKS IN THE POST-TRADE MARKET
2.1.1. Cross-Border Transaction Risk
A cross-border securities transaction is much more complicated and risky than a domestic one, it is
defined as a settlement that takes place in a country (or currency area) in which one or both parties
to the transaction are not located. Normally, it involves a greater number of participants than a
domestic transaction, and the use of multiple intermediaries increases transaction costs, and the
custody risk to the parties involved. It also increases the possibility of losing securities, because of,
for example, insolvency of the custodian. In addition to the risks mentioned, the trade’s international
aspects rises the level of operational and credit risk, also legal risk, which contains an unexpected
intervention of a foreign law or regulation that makes the contract enforceable. The customer also
faces foreign exchange risk, when the trade is done between two currencies. The currencies’
movements can affect the price of the security between trading and settlement dates.
There are some risks specific to the both type of transactions: domestic or not, the settlement risk,
counterparty risk, operational risks, credit risks and liquidity risks. The main threats jeopardizing an
investor are: securities are delivered but no cash received, or vice versa, because of a default of a
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counterparty or intermediary; the possibility that either one of the counterparties may fail to meet
their obligations; and the liquidity risk, that either one of the counterparties fails to settle the trade
on the due date. Settlement risk is the risk that settlement in a transfer system will not take place as
expected, usually owing to a party defaulting on one or more settlement obligations. The settlement
failure, or the inability of a participant to meet its settlement obligations in a system can occur when
there is a temporary or permanent inability of the settlement agent, the institution across whose
books transfers between participants take place (Giovannini, 2003). The risk is limited by ensuring a
DVP basis for settlement of securities transactions. It makes settlement of securities conditional on
provision of cash, or vice versa. DVP procedures reduce, but do not eliminate this risk, because there
can be a risk that the failure of a CSD participant could result in systemic disruptions.
2.1.2. Counterparty risk
All the investors conducting transactions in financial instruments, including derivatives transactions,
implement risk mitigation processes and control, in order to reduce the exposure to the counterparty
risk. The more counterparties an organization has exposure to, the greater are the risks and so are
the costs. According to Giovannini, the presence of CCP marks the great difference between the
riskiness of the settlement flow on the Regulated Market and OTC. Thus, from the point of view of
market participants, the credit risk of the CCP is substituted for the credit risk of the other
participants. A CCP can lower these costs by reducing the number of counterparty business
relationships. On the regulated market, while using a CCP, the participants can deal with any
counterparty that it knows is eligible to use the CCP without extensive due diligence, as its
contractual relationship and risk exposure will only concern the CCP.
Buyer
Clearing Member
Settlement Agent
CSD Central Securities
Depositary
Clearing House
Trading Platform
Seller
Clearing Member
Settlement Agent
Image 3 Settlement Flow on a Regulated Market
Unlike in exchange transactions, where trades are matched up and guaranteed by the exchange, on
the OTC Market, clearing and settlements of trades, are still left to the buyer and seller, on a non-
standardized basis and continue to require a considerable degree of manual intervention. In OTC
markets, participants trade directly with each other, typically through telephone or computer links.
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Post-trading infrastructures for OTC derivatives have therefore struggled to cope with the growing
volume and complexity of OTC derivatives trades in recent years. The dealers in an OTC security can
withdraw from market making at any time, which can cause liquidity to dry up, disrupting the ability
of market participants to buy or sell (IMF,2017)6. The inherent opacity of OTC derivatives markets,
lack of market discipline and ineffective management, creates a large risk exposure for the financial
institutions.
Bank A
Bank B
Bank C
Bank D
Bank E
Bank F
Image 4 Settlement Flow on OTC Market
The IMF says that counterparty risk on OTC market could be substantially minimized if bilateral
contracts were cleared through a central counterparty mechanism, which essentially acts as
counterparty to all counterparties, through the enforcement of the robust risk management
standards, the sharing of losses of members of CCPs, and multilateral netting7.
2.1.3. Operational risk
In order for a transaction to be settled, it should be first confirmed and matched, operations usually
performed by the back offices of the direct market participants, indirect market participants and
custodians. They need to prepare settlement instructions, which should be matched prior to the
settlement date8. Speedy, accurate verification of trades and matching settlement instructions is an
essential precondition for avoiding settlement failures, especially when the settlement cycle is
relatively short. Many markets have introduced the automation of trade confirmation and
settlement matching systems. According to Committee of European Securities Regulators, STP allows
the automatic, interoperable, comparison of trades between direct market participants. At its most
sophisticated, automation allows manual intervention to be eliminated from post-trade processing.
STP allows trade data to be entered only once, and then those same data are used for all post-trade
requirements related to settlement.9 The implementation of STP requires CSDs, market operators,
custodians, brokers, dealers and investment firms, one precondition: the adoption of universal
6 http://www.imf.org/external/pubs/ft/fandd/basics/markets.htm 7 https://www.imf.org/en/Publications/WP/Issues/2016/12/31/Counterparty-Risk-in-the-Over-The-
Counter-Derivatives-Market-22447 8 This only applies to settlement cycles that extend beyond T+0, and only for transactions where
matching is required. 9 https://www.esma.europa.eu/sites/default/files/library/2015/11/10_610.pdf
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messaging standards and communication protocols in order to have timely access to accurate data
for trade information enrichment, mainly with regard to clearing and settlement details. The longer
the period from trade execution to settlement, the greater the risk that one of the parties may
become insolvent or default on the trade; the larger the number of open trades prior to settlement;
and the greater the opportunity for the prices of the securities to move away from the contract
prices, increasing the risk that non-defaulting parties will incur a loss when replacing the unsettled
contracts. The timing of settlement finality, or the time at which the deliveries of securities or cash
become both irrevocable and enforceable, it should be clearly defined by the rules of the system, or
national legislation, and should apply to all participants. Intraday finality can be provided through
real-time settlement 10procedures or multiple batches processing during the settlement day.
2.1.4. Legal Risk
The rules and contractual arrangements related to the operations of the securities settlement
systems and the entitlement to securities should be valid and enforceable, even in the event of the
insolvency of a system participant. The operators should identify the relevant jurisdictions for each
aspect of the clearing and settlement process, and should address any conflict of law issues for cross-
border systems. All eligible CSDs governed by the law of an EEA Member State should apply to have
their securities settlement systems designated under the European Directive 98/26/EC on settlement
finality in payment and securities settlement systems. The relevant authorities should actually
designate the systems that meet the criteria of the Settlement Finality Directive. The rules governing
the system should clearly indicate the law that should apply to each aspect of the settlement
process. The operators of cross-border systems must address conflict of law issues when there is a
difference in the substantive laws of the jurisdictions that have a potential interest in the system.
2.2. SECURITIES TRADING AND SETTLEMENT
An important strand in the financial literature focuses on the analysis of the efficiency of settlement
process and different form of financial integration. According to Ian Domowitz and Ruben Lee (The
Legal Basis for Stock Exchanges: The Classification and Regulation of Automated Trading Systems,
1998),” at the most general level, a market may be thought of as a forum for executing a trade. In an
equity market, the standard trade cycle is composed of many different activities, including
consideration of pre- and post-trade information, order routing, order execution, matching, clearing,
settlement and custody. A trading system is defined here to be a mechanism which delivers three of
these functions - trade execution, order routing, and data dissemination. Also, they debate some
international issues. Despite the fact, that it is now technologically relatively easy to construct cross-
border automated securities trading systems, only a few have been developed. Of these, only a small
number have actually been successful. One reason why so few cross-border systems have been built
is that many of the regulatory problems associated with their operation have not been adequately
addressed. These questions are, however, not easy to answer. They are often complex, controversial,
politically charged, and not given the highest priority for attention by domestic regulators and
legislators. Furthermore, apart from the various institutions of the EU, there is no institutional
framework for enforcing any agreed international policy.
10 Real-time gross settlement (RTGS) is the continuous settlement of securities transfers individually on
an order-by-order basis.
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Thomas Gehrig (Cities and the Geography of Financial Centres, 1998) emphasised that „financial
activities based on straightforward, generally available information tend to be centralized. For
example, limit orders and market orders consist of a high degree of simple and standardized
information. The processing of such standardized financial activities is therefore a technical matter
and does not rely on complex local or issuer-specific information.
The investment cycle starts with the formation of the investment decision. In the pre-trade phase,
the investors meet the fund managers or asset managers to conclude their investment strategy,
according to their objectives and risk appetite. Trading represents the buying and selling of the
securities or commodities, between two brokers on a short-term basis.
Image 5 Settlement Chain
The post-trade phase represents the transfer of the ownership and custody management of the
securities. The post-trade services represent the safe and smooth conclusion of a security
transaction, involving the securities clearing and settlement. Clearing and settlement institutions
guarantees that these transactions are performed safely and efficiently. Custody management
includes the safekeeping and administration of securities on behalf of others. The post-trade phase
involves 4 main activities: confirmation, clearance, delivery and payment, and each activity is crucial
for the completing of the trade. Delivery of securities and payment of funds may occur
simultaneously, and only when both delivery and payment have been finalized, the settlement of the
securities transaction is achieved. The process of clearing and settlement begins when a securities
trade has been executed. The first step is to ensure that the buyer and the seller agree on the terms
of the transaction, referred to as trade confirmation. The trade confirmation or affirmation should
preferably occur without delay after trade execution, but no later than T+1. This measure will help to
avoid errors in recording trades, inaccurate books and records, also will reduce mismanaged market
risk and credit risk. Delivery requires the transfer of the securities from the seller to the buyer. The
most common type is delivery versus payment (DVP), a way of controlling the risk to which securities
market participants are exposed. In such a settlement, there is a link between a securities transfer
system and a fund transfer system ensuring that delivery of securities is done simultaneously with
payment, assuring that neither the buyer nor the seller is exposed to settlement risk. Often, when a
CSD does not itself provide cash accounts for settlements, the underlying securities are first blocked
in the account of the seller or at the seller’s custodian. The CSD then requests the transfer of funds
from the buyer to the seller in the cash settlement agent. The securities are delivered to the buyer or
the buyer’s custodian only if the CSD receives confirmation of settlement of the cash leg from the
settlement agent. A financial institution that deals with global markets ought to build a network of
cash correspondents and sub-custodians, these intermediaries (banks) will give to their customer’s
access to the market of the country they are residents. This network is sophisticated and the links
between the participants are created at every step of the investment cycle. Heiko Schmiedel in
„Performance of international securities markets (“Bank of Finland Studies E: 28 2004), describes the
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3 types of organizations providing clearing and settlement services: CSDs, ICSDs, and custodians.
Historically, ICSDs’ main function was to settle Eurobond trades. They are now active in clearing and
settlements across different international markets and currency areas. The custodian holds a
securities account on behalf of its client, and saves the results of all its transactions for the purchase
and sale. It is an entity, usually a bank, that safe keeps and administers securities providing various
services as clearance, settlement, cash management, foreign exchange and securities lending.
Image 6 Market Participants
A custodian provides to an investor a place to store assets with little risk, because it reduces the risk
of the client losing the assets or having them stolen. While the correspondent maintains a cash
account on behalf of its client, used to pay and receive currency. Correspondents and custodians are
the way to go directly to a local market. The local custodians, provides custody services for securities
traded and settled in the country in which the custodian is located. It is considered a good partner for
a successful post-trade processing, as it is in the local market and has deep understanding of local
practices and rules, can digest and communicate fast the operational and strategic challenges
introduced by the new market regulation. The following financial institutions are the 6 largest
custodians by assets under custody11: The Bank of New York Mellon Corporation from USA, Euroclear
located in Belgium, J.P. Morgan from USA, State Street Corporation and Citi from USA, BNP Paribas
Securities Services from France. The drawback of using a local custodian is that for every new
currency, each new securities market, the investors need to find a new supplier. Usually, the
11 The Bank of New York Mellon Corporation from USA (24,266,267 USD millions), Euroclear located in
Belgium (19,407,827 USD millions), J.P. Morgan also from USA (16,032,933 USD millions), State Street Corporation from USA (15,794,657 USD millions), Citi from USA (12,600,000 USD millions), BNP Paribas Securities Services from France (6,205,000 USD millions). Web source: http://financialmarkets.theasianbanker.com/custodians-by-assets-under-custody
20
institutional investors and large companies involved in financial markets delegate their securities and
cash assets to the global custodians. The global custodian provides custody services for securities
traded and settled not only in the country, where the custodian is located, but it serves as a single-
entry point for worldwide operations, through a net of cross-border experts, providing the possibility
to hold a single account (in multicurrency) opened for all markets, single contractual relationship to
be signed for all markets, and the management of FOREX. To do this, the global custodian is in
contact with a network of sub-custodians located in domestic markets, which give them the access to
the markets where the customers trade, and the CSD of the country of residence of the client. These
global custodians are typically members of many national CSDs, or have access to membership via
local custodian. The transactions itself are settled via a settlement agent, an institution appointed by
the client and authorized to instruct and settle transactions with a CSD/ICSD. Its responsibilities are:
check the validity of the trades, repair the trades whenever necessary; control the stock and cash
positions; release the instructions and settle the instructions. CSD is the institution associated with
the national market, that holds the securities and they can never leave its CSD, because the exchange
of asset ownership can only take place within a domestic market. As an example, each country has its
own CSD, which houses all the shares from that country. Those shares never cross the border,
regardless of the nationality of the investors who buy or sell them: an Italian share, no matter who it
belongs to, will remain in Monte Titoli, when a German one will remain in Clearstream Frankfurt. It is
a centralized organization, the official holder of all the national securities on a market, where
securities can be available for clearing and settlement. It guarantees to its clients the relay and the
processing of all financial information to its members’ participants. The 3 main services provided by a
CSD are: issuance or first entry point for newly created securities, the settlement of the securities
and safekeeping. Not like a CSD, that deals only within the perimeter of the national borders, the
ICSD (International Central Securities Depository) offer a set of services in area of the issuance and
asset management of international securities, as Clearstream International, Euroclear Bank, SIX SIS.
Beside these participants in the post-trade process, the Central Bank plays an important role,
meaning that, if the securities accounts are held by the CSDs, the cash accounts are held by the
Central Bank. The Central Bank is in charge to issue and control the money supply for a specific
currency.
Kauko (Interlinking securities settlement systems: A strategic commitment? 2007) explores a
different dimension of the industrial organization of central securities depositories. In his model, it is
recognized that CSDs operate simultaneously in two different markets. These are the primary market
for securities (where it was issued), and the secondary market for settlement, where the transfer of
legal ownership occurs. As Kauko demonstrates, for profit, CSD is faced with a commitment problem.
Once securities are issued then a profit maximizing CSD will seek to maximize net revenues from
secondary market settlements. But this in turn will raise the costs of secondary trading, reduce
volumes and liquidity in secondary markets, and hence reduces the value to both investors and
issuers of primary market issuance. The CSD will achieve higher profits and investors will achieve
higher utility, if the CSD can pre-commit to maintaining relatively low secondary market pricing.
Kauko’s specific objective is to analyse the potential role of “links” between CSDs. He noted that
many national CSDs have established communication links, which allow other national CSDs to
provide indirect access to their securities accounts.
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Giddy, Saunders, and Walter (1996) in “Alternative Models for Clearance and Settlement: The Case of
the Single European Capital Market”, emphasize the fact that most CSDs are properly viewed as
multiproduct organizations, which adds to the complexity of assessing the level and structure of total
costs of clearance and settlement systems and their efficiency. This complexity derives from the fact
that clearance and settlement costs can be viewed as a subset of the transaction costs facing an
investor in effecting a trade. The key feature of the clearance and settlement value chain is that it
involves a sequence of related services, of which actual securities clearance and settlement is but
one element. CSDs rarely handle a single class of securities, or provide a single type of service, but
offer a range of services that create potential economies of scope and scale.
Clearing provides a smoother and more efficient market. According to BIS (in Capital requirements
for bank exposures to central counterparties, 2012), the Clearing House is a financial institution
through which participants agree to exchange instructions for funds, securities or other instruments.
It interposes itself between the counterparties to a trade, becoming the buyer to every seller and the
seller to every buyer. It plays a critical role in the stability and efficiency of financial markets, taking
on significant financial risks by:
• Guaranteeing anonymity of transactions
counterparties through the post-trade process.
• Eliminating bilateral counterparty risk until
settlement, as CCP becomes the counterparty
to both parties, and if one party fails to meet
its obligations, the CCP will ensure the other
party is not affected and will fulfil the
obligations with the remaining counterparty.
• Managing risk through collateral, a CCP
evaluates the counterparty exposure to
outstanding obligations, and it requires the
market players to deposit collateral, in the
form of cash or securities.
The clearing agent is a local bank that settles trades in
the market and delivers on to the custodian, he receives shares to sell them or buy shares to deliver
them.
Lamfalussy Group, (The Committee of Wise Men, governed by Chairman Alexandre Lamfalussy) in
the Final Report of the Committee of Wise Men on the Regulation of European Securities Markets
(Brussels, 2001), has underlined the role of efficient clearing and settlement arrangements in
delivering the economic benefits from the broader process of EU financial integration. The
Committee argues that further restructuring of EU clearing and settlement arrangements is
necessary, stressing that "the process of consolidation should largely be in the hands of the private
sector". The Committee reaffirms its view that there are significant gains from building an integrated
financial market in the European Union. An integrated European financial market will enable, subject
to proper prudential safeguards and investor protection, capital and financial services to flow freely
throughout the European Union. The barriers - unnecessary bureaucracy, lack of trust, and
sometimes downright protectionism - will become things of the past. European businesses, large and
small, will be able to tap deep, liquid, innovative European capital pools, centred around the euro for
Image 7 Clearing House
22
the financing they require to develop their business activities. However, the Committee also
highlights the public policy interest in having the most cost-efficient, competitive and prudentially
sound arrangements possible.”
Holthausen and Tapking (Raising Rival’s Costs in the Securities Settlement Industry, July 2004)
analysed the competition between a central securities depository and a custodian bank in the
Stackelberg model. The CSD sets its prices first, the custodian bank follows. There are many investor
banks, each of which has to decide whether to use the service of the CSD, or of the custodian bank.
This decision depends on the prices and the investor banks preferences for the inhomogeneous
services of the two service providers. Since the custodian bank uses services provided by the CSD as
input, the CSD can raise its rivals’ costs. However, due to network externalities, the CSDs equilibrium
market share is not necessarily higher than socially optimal. Their model explores a trade-off
between client preferences, between the two settlement providers (the CSD and the agent bank) and
a network effect, the additional cost of cross-firm settlement between an investor accounts on the
CSD and investor accounts at the agent bank. The limitations of their study are that in the real world
the competition between agent banks and CSDs for settlement volume, on which they focus, is not of
great relevance. The agent banks key function is to provide technical connectivity to CSDs for those
brokers who do not wish to bear the operational costs of interacting with CSDs, costs such as
maintaining IT connections, monitoring and tracking account balances, and dealing with processing
exceptions. Bilateral link between CSDs, is the most recently available, but probably the least used
option by non-residents. Links between CSDs offer advantages by reducing the number of entities
involved in the settlement process and by allowing investors to more easily and cheaply meet any
collateral requirements. To conclude, the settlement system of a cross-border transaction can be
achieved by using one of these types of access:
• Direct access to a national CSD in the country where the security is issued. Direct access
implies participation/membership in the national CSD, which involves signing legal
agreements, complying with membership requirements, investing in technological
interfaces and access to a payment mechanism.
• Services of a local agent, which is normally a financial institution with membership in the
national CSD, in the country where the security is issued. This is the most common
option used for cross-border settlement of equities transactions. The local agent offers
the non-resident a full range of settlement, banking and custody services, as well as
services for tax purposes, processing of corporate actions.
• ICSDs, that operate mainly in the settlement of internationally-traded fixed income
instruments, but offer a single access point to national markets via links to many national
CSDs.
• Global custodian, which also provides customers with a single access point to national
CSDs in various countries, via a network of sub-custodians.
Tapking and Yang (Horizontal and Vertical Integration in Securities Trading and Settlement, 2006)
analyse the welfare effects of different forms of consolidation amongst trading and settlement
institutions. They find that full technical horizontal integration of settlement systems is better than
vertical integration of exchanges and settlement systems. These findings have clear policy
implications with regards to the highly fragmented European securities infrastructure. Their model
supports three principal conclusions. First, they show that vertical integration (integration of trading
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infrastructure with clearing and settlement infrastructure) leads to a welfare improvement, when
compared with competitive separation. Clearing and settlement are inputs to the total trading
service of executing, clearing, and settling a securities trade. Trade execution without subsequent
clearing and settlement is incomplete and hence of no value to the investor. The three services -
trade execution, clearing, and settlement are therefore different elements of a composite good.
Suppose, therefore, that total trading demand is given by V(p), where total execution price p is the
sum of the price of trading pt and the price of clearing and settlement ps (for simplicity clearing and
settlement will be treated as a single service, but the argument is only strengthened when these are
recognized as distinct services): p=pt+ps. Consider first separation of the trading platform and the
settlement infrastructure. Simplifying by assuming operating costs are zero, the profit of the trading
platform is then given by ptV, with the first order condition for profit maximization:
Implying that the price of trade execution equals the inverse of the price elasticity of trading
demand: pt = V/dV(pt + ps)/dpt = 1/η. Similarly ps = V/dV(pt + ps)/dps = 1/η, so the total price of
trading is given by p=pt+ps=2/η. With vertical integration, we instead have p = 1/η, so prices are
considerably closer to the socially efficient level of p=0 under vertical integration than with
separation. Further, Tapking and Yang show that horizontal legal integration at the lower (CSD) level
can facilitate competition between exchanges and improve welfare, while technical integration,
removing costs of linking between the CSDs, is always better for social welfare, than purely legal
integration.
2.3. T2S PROJECT IMPLEMENTATION
Aiming to develop its own unique settlement business model, in July 2008, the Euro System of
Central Banks launched T2S. The T2S project main goal is to diminish the risks and costs during the
settlement process. Deutsche Bundesbank, Banco de Espana, Banque de France and Banca d’Italia
have been mandated to build the system and operate it live. One of the key objectives of T2S project
is to assure safety by using DVP mechanism, while efficiency is achieved via settling cash (T2
Platform) and securities (T2S) on the same IT platform, supervised by the same entity, ECB. T2S uses
CCP netting which is usually the most effective way for settlement when the securities are held on
omnibus accounts. Due to its complexity, the project was divided in 5 waves. TS2 was initially
planned to go live in Q2 2013, but due to the multitude of players, it was postponed several times
and the first CSDs migrated in June 2015.
24
Wave 1
22 Jun 2015 - 31 Aug
2015
Wave 2
29 Mar 2016
Wave 3
12 Sep 2016
Wave 4
6 Feb 2017
Final wave
18 Sep 2017
Bank of Greece Securities
Settlement System
(BOGS)
INTERBOLSA
(Portugal)
Euroclear
Belgium
Centrálny
depozitár cenných
papierov
Baltic CSDs
Depozitarul Central
(Romania)
National Bank of
Belgium
Euroclear
France
SR (CDCP)
(Slovakia)
(Estonia, Latvia,
Lithuania)
Malta Stock Exchange Securities
Settlement
Systems (NBB-
SSS)
Euroclear
Nederland
Clearstream
Banking
(Germany)
Iberclear (Spain)
Monte Titoli (Italy) VP Lux
(Luxembour
g)
KDD - Centralna
klirinško depotna
družba (Slovenia)
SIX SIS (Switzerland) VP Securities
(Denmark) KELER (Hungary)
LuxCSD
(Luxembourg)
OeKB CSD
(Austria)
Table 1 T2S Implementation waves
There are 23 central securities depositories in the European region that moved to T2S. Migrations
took place in waves, with the first wave accomplished on 22 June 2015, and the final - September
2017. The migration took place over several weekends in order not to impact the production. The
objective of the migration phase is to enable a smooth and successful transition to the usage of T2S
services for the CSDs, central banks and their communities. On the Monday morning following these
migration weekends CSDs will be operationally settling in T2S. 4th wave was the largest T2S
migration wave, in terms of both the number of CSDs and the increase in settlement volumes, the
volume of securities transactions being settled on the platform has almost doubled, with 18 CSDs,
representing 16 markets.
2.3.1. T2S Principles
According to ECB, the project was aligned to 19 principles12:
1. The Eurosystem shall take on the responsibility of developing and operating T2S by assuming
full ownership
2. T2S shall be based on the TARGET2 platform and hence provides the same levels of
availability, resilience, recovery time and security as TARGET2
3. T2S shall not involve the setting-up and operation of a CSD
12
https://www.ecb.europa.eu/paym/t2s/pdf/T2S_AG_meet4_aob.pdf?1c3546f73a61277131005738cc2dd363
25
4. T2S shall support the participating CSDs in complying with oversight, regulatory and
supervisory requirements
5. The respective CSD customers’ securities accounts shall remain legally attributed to the CSD
and the respective central bank customers’ cash accounts shall remain legally attributed to
the central bank.
6. T2S shall settle exclusively in central bank money
7. The T2S settlement service allows CSDs to offer their customers at least the same level of
settlement functionality and coverage of assets in a harmonized way
8. Securities account balances shall only be changed in T2S
As stated above, T2S is a service for enhancing the efficiency of securities settlement across Europe,
while at the same time keeping central banks’ cash account management.
9. The primary objective banks. Its scope is therefore limited exclusively to central bank money
and does not extend to the settlement of commercial bank money. of T2S is to provide
efficient settlement services in euro
10. T2S shall be technically capable of settling currencies other than the euro
11. T2S shall allow users to have direct connectivity
12. CSDs’ participation in T2S shall not be mandatory. CSDs’ participation in T2S is a business
decision on the part of the CSDs and their local market community. When deciding whether
or not to join T2S, CSDs are expected to follow the interests of their shareholders and
customers.
13. All CSDs settling in central bank money and fulfilling the access criteria shall be eligible to
participate in T2S
14. All CSDs participating in T2S shall have equal access conditions
15. All CSDs participating in T2S shall do so under a harmonized contractual arrangement
16. All CSDs participating in T2S shall have a calendar of opening days with harmonized opening
and closing times for settlement business
17. T2S settlement rules and procedures shall be common to all participating CSDs
18. T2S shall operate on a full cost-recovery and not-for-profit basis. The Eurosystem prices the
development and operation of T2S on a full cost-recovery and not-for profit basis. While
delivering a very high level of service in terms of quality, security and availability, T2S also
seeks to be as cost-efficient as possible.
19. T2S services shall be compatible with the principles of the European Code of Conduct for
Clearing and Settlement T2S shall be compatible with the principles of the European Code of
Conduct for Clearing and Settlement with regard to price transparency, the unbundling of
services and accounting separation.
2.3.2. T2S Harmonization Activities
In order to ensure the efficient harmonization towards the post trade environment, there were
implemented 24 activities. They were divided in priority 1 and priority 2 activities, managed by the T2S
team at the ECB, under the guidance of the Harmonisation Steering Group (HSG) and the endorsement
of the T2S Advisory Group. Priority 1 activities are necessary to ensure efficient and safe cross-CSD
settlement in T2S. The HSG and the T2S team should focus on these activities as first priorities for
resolution and implementation prior to the launch of T2S.
26
1. T2S introduces new ISO 20022 messages
The T2S users will communicate with the technical platform using ISO 20022,
an ISO standard for electronic data interchange between financial institutions. ISO 20022 compliant
messages is the successor to ISO 15022. It describes a metadata repository containing a set of 130
messages, customized to the specific needs of T2S, business processes, and a maintenance process
for the repository content. SWIFT Standards Consulting Services has been supporting the T2S project
since 2008.T2S instruction types are as follows: Settlement Instructions - settlement of securities and
cash leg of transactions; Settlement Restrictions - blocking, reserving and earmarking of securities
and cash positions on T2S accounts; Maintenance Instructions- cancel, hold/release and amendment
instructions; Liquidity Transfers-liquidity transfers between DCAs and DCA-T2 transfers.
2. T2S mandatory matching fields
With the implementation of T2S there are new matching criteria with mandatory, additional and
optional matching fields. T2S actors are required to use mandatory and non-mandatory T2S matching
fields. Mandatory matching fields are those fields that must be present in the instruction and which
values should be the same in both settlement instructions: for example, payment type, securities
movement type, ISIN Code, trade date, settlement amount, intended settlement date, delivering
party, receiving party, CSD of the Delivering Party, CSD of the Receiving Party, currency. Non-
mandatory matching fields can be additional or optional: additional matching fields are initially not
mandatory but their values have to match when one of the counterparties provides a value for them
in its instruction (Opt-out ISO transaction condition indicator, CUM/EX indicator). In case of optional
matching fields, a filled-in field may match with a field with no value, but when both parties provide
a value, the values have to match (common trade reference, client of delivering CSD participant,
client of receiving CSD participant). T2S also offers the possibility to prioritize the settlement
instructions: from high to low. Reserved priority is assigned only by a CSD or NCB. Top priority is
assigned automatically to trading venues and CCP transactions. High and normal priority can be
assigned by T2S actors to their settlement instructions.
3. Interaction with T2S (tax info requirements)
To avoid complexity and confidentiality issues, for intra-CSD or cross-CSD transactions, no tax-related
information should be included in T2S settlement messages. Some of these taxes related information
is tax status of transaction, tax status or tax id of end investor, tax exempt identification number,
alien registration number, passport number, corporate identification, driver license number, foreign
investment identity number, BIC, proprietary id, name and address of investor. As ISO messages also
provide fields that can be used to pass information about a particular transaction tax type
(withholding tax, payment levy tax, local tax, stock exchange tax, transfer tax, value added tax,
consumption tax) specifying amount, debit/ credit indicator, currency and other details, such fields
should not be used to pass on any kind of tax related information.
4. T2S schedule of the settlement day and calendar
One of the key harmonization agreements in the T2S context is the use of a single schedule for the
T2S settlement day and a single calendar per currency, and CSDs should be fully compliant with it.
27
Time T2S periods High level description
6.45 p.m. -7.30 p.m. SOD: Start of Day Change of business date in T2S and
preparation for night-time settlement.
7.30 p.m.-3.00 a.m. NTS: Night-time Settlement Settlement with multiple cycles (proposed 2
cycles) in night-time settlement period
• First night-time cycle with reporting and
static data update
• Last night-time cycle (with partial
settlement) with reporting and static data
update.
3.00 a.m. -6.00 p.m. RTS: Real-time Settlement
(with a maintenance
window)
Real-time settlement followed by settlement
with partial settlement periods and real-time
settlement closure period
6.00 p.m. -6.45 p.m. EOD: End of Day Close of the current T2S business day
Table 2 T2S Day Schedule
5. T2S corporate actions standards
Asset services offered by CSDs, such as corporate actions (CA), play an increasingly important role in
the competition framework of the securities post-trade industry. Considering the fact that they will
all use the same, T2S platform for settlement related to processing of corporate actions, there is an
urgent need for harmonization. For example, in a cross-border scenario, where securities holdings
are recorded in multiple CSDs, persistence of divergent practices of markets in T2S would result in
unnecessary costs and high rates of matching fails during the processing of corporate actions in the
cross-border environment. In September 2009, the T2S Advisory Group (AG) approved the T2S CA
standards for processing corporate actions on flows, which had been prepared by the T2S Corporate
Actions Sub-group CASG, a group composed of experts on CA processing from CSDs, central
counterparties (CCPs), and their participants.
The corporate actions on flow, or transaction management, include market claims, transformations
and buyer protection, and they occur only on matched instructions in T2S. The challenges for CA
transaction management in the cross-CSD environment of T2S stem from the fact that more than one
CSD may be involved. Therefore, for the purposes of the T2S CA standards, a new concept has been
introduced: the instruction owner CSD (IOC), the CSD that provides the securities accounts on which
the participant has sent a settlement instruction. Thus, the IOC is the same CSD for both instructions
if the transaction is between two of its participants. However, there will always be two IOCs in a
cross-CSD transaction in T2S.
In the case of corporate actions on “stock” (cash distribution, securities distribution, distribution with
options, mandatory reorganization with options, voluntary reorganization), minimal change is
expected in T2S in relation to the current practice of cascading delivery of proceeds (both in the form
28
of securities and cash), via the chain of investment intermediaries to the end investors, as described
in the European CA market standards.
6. Settlement Finality I. Moment of entry of transfer order into the system.
The aim of this T2S harmonization activity is to agree on a common T2S rule regarding the moment
of entry of a transfer order into the system and to ensure compliance by all T2S markets. The
irrevocability of transfer orders in T2S is protected through the rule prohibiting the unilateral
cancellation of instructions after matched status is achieved in T2S. According to T2S Framework
Agreement, contracting CSDs shall make all necessary arrangements in order to adopt a
harmonized definition of the irrevocability of transfer orders, in order to eliminate the risk of
transfer order revocation in a T2S cross-border environment.
7. Settlement Finality II. Irrevocability of transfer order.
According to Article 21/para.4 of the T2S Framework Agreement, in order to facilitate legally sound,
seamless cross-border DVP settlement, the regulatory/legal environments of the CSDs participating
in T2S have to recognize account entries in T2S as unconditional, irrevocable and enforceable.
8. Outsourcing IT services
T2S represents, firstly, a technical IT platform and it is important to ensure that all participating CSDs
obtain regulatory approval before outsourcing settlement services to T2S. The CSD Regulation is
expected to harmonize the legal framework for IT outsourcing to bodies.
9. Settlement discipline regime
T2S introduces for the fragmented EU post-trade arena, a harmonized settlement discipline regime,
in order to avoid the risk of multiple inconsistent or incompatible regimes that would create
operational complexity. It will also ensure a level playing field to avoid the risk of so called
"regulatory arbitrage", and to reduce fails. The New CSD Regulation is expected to harmonize
settlement discipline regime in the EU.
10. Settlement cycles
On October 6, 2014, most T2S markets have migrated to T+2 settlement cycle. It can be considered
one of the most crucial harmonization activities, allowing T2S participants to rationalize the technical
infrastructures in back-office activities, as well as in managing cross-border corporate actions.
11. Availability of omnibus accounts T2S standard
CSDs offer different types of segregations, omnibus, segregated or a hybrid option, a combination of
the both. This reflects the local market constraints, law or market participant preferences, in terms of
investor protection and issuer transparency. Even if CSD provides all of them, in T2S, in cross-border
scenarios, for CSDs participating, individual client or end investor account segregation typically does
not apply. CSD links operate on the basis of omnibus accounts in order to avoid complex and
inefficient procedures for cross-border settlement. This is a crucial requirement for delivering the T2S
benefits of cross-CSD settlement in the EU. Issuer CSDs in T2S must offer omnibus accounts to their
foreign participants to ensure interoperability and cross-CSD settlement.
29
12. Restrictions on omnibus accounts
To make full interoperability, issuer CSDs in T2S should ensure foreign participants the possibility of
opening omnibus accounts, and must provide appropriate services on omnibus accounts to foreign
participants, as required by participants. These omnibus accounts should also include, as an option,
holdings of domicile and non-domicile investors.
13. Securities accounts numbering (SAC)
In T2S, CSDs open a SAC on behalf of their participants, and each SAC must be linked to one or more
DCA (only one should be set as a default cash account). Every SAC is univocally identified at CSD level,
even if the participant can open an unlimited number of those securities accounts. As mentioned
above, T2S does not allow distinguishing of securities account between proprietary and third-party
account; it remains under the CSD responsibility. In securities account numbering, CSDs must use BIC
4 digits to identify parties of CSDs plus 31 digits of free text.
14. Dedicated cash account numbering (DAC)
Central Bank opens a DCA on behalf of their participants, although a T2S participant may have its
own securities account with DCA of a different payment bank. Each DCA must be linked with a RTGS
account and at the end of each T2S day, the cash liquidity present in the DCA will move in to the
RTGS account, in form of an outbound liquidity transfer. The DCA account numbering standard
includes 34 characters (1 to designate the cash account, 2 for the country, 3 for the currency code, 11
for the BIC and 17 characters of free text for the account holder).
The priority 2 activities are not essential, but they are key for enhancing the competitive
environment and the efficiency of T2S.
Location of securities account. Conflicts of law - The location of securities accounts must be clearly
determined, harmonized and compatible with the set-up of T2S, so as to mitigate legal risk for CSD
links in T2S. The location of the account is linked to the place of business of the CSD, where the
securities are or used to be physically located. European Commission, in its Discussion Paper of 1
February 2010 (MARKT.G.2/ (2010)57731), states that it is applicable the law of the country where
the branch is located, where the account was opened and where the commercial relationship is
handled.
Corporate Actions Market standards - The problem of heterogeneous national market practices with
regard to corporate actions was identified by Giovannini (2001 report), as one of the barriers to
efficient cross-border settlement in the EU. The Corporate Actions Joint Working Group (CAJWG), an
industry working group formed by issuers, market infrastructures and market participants, created
the “Market Standards for Corporate Actions Processing”. The aim was to streamline corporate
actions processing so as to reduce costs and operational risks for market participants. These market
standards provide the basis for the T2S corporate actions standards, in key areas, as information
flows, sequence of key dates, and operational processing, mandatory for every market and CSD.
According to the market CA standards, it is the issuer who should inform the issuer CSD of the details
of a CA as soon as it has been publicly announced. The information must then reach the end investor
through the chain of CSDs and relevant investment intermediaries. The CA market standards is
following the path of information on the top -down approach, also known as the Christmas tree
30
model, the information is passed from the issuer down the chain of investment intermediaries to the
end investors.
Securities amount data - In line with the current standard market practice in the EU, T2S markets
should define securities amount data by using nominal value for debt instruments and units for non-
debt instruments (debt instruments in FAMT and equities in UNIT). The objective of this activity is to
ensure that all T2S markets are aligned with the EU’s standard practice for defining securities amount
data in the trading, clearing and settlement chain. Some more practical changes introduce on the
settlement flow are the new market cash tolerance and the cancellation of instructions. Before T2S,
cash tolerance level was 25 EUR, and in T2S, it is of 2 EUR for counter values less than or equal to
100000 EUR, and 25 EUR for counter values of over 100000 EUR. In T2S the cancellation of matched
instructions is done bilaterally (unilateral is not possible as Pre-T2S). The unmatched instructions will
continue to be cancelled unilaterally.
2.4. T2S AND THE NEW EU REGULATION
T2S Project has grown in a period when European Union together with all the other countries was
passing through the severe consequences of the financial crises. The near-collapse of Bear Sterns in
March 2008, the default of Lehman Brothers on 15 September 2008, and the bail-out of AIG the
following day, highlighted the shortcomings in the functioning of the financial market and has proven
that the downsize in US market impacts immediately each market. On 23 September 2009, the
Commission adopted proposals for three regulations establishing the European System of Financial
Supervision, including the creation of three European Supervisory Authorities (ESAs). The ESAs
comprise the European Banking Authority (EBA), established by Regulation (EU) No 1093/2010 of the
European Parliament and of the Council (4), the European Insurance and Occupational Pensions
Authority (EIOPA), established by Regulation (EU) No 1094/2010, and the European Securities and
Markets Authority (ESMA), established by Regulation (EU) No 1095/2010. The ESAs have a crucial
role to play in safeguarding the stability of the financial sector. The T2S project will be a catalyst for
further harmonization of post-trade practices and regulations across Europe. T2S, together with an
ambitious regulatory agenda, including MIFID 2, MIFIR, EMIR, CSDR and UCITS V, will reshape the
structure of the complete value chain, from trade execution to post-trade functions.
2.4.1. The Regulation on settlement and Central Securities Depositories (CSDR)
It was adopted by the European Parliament, on 15 April 2014, and it has the scope to uniform
requirements for the settlement of financial instruments in the Union, and rules on the organization
and conduct of CSDs, to promote safe, efficient and smooth settlement. The CSDR applies to
European CSDS and any entities being participants in that CSDs. It introduces:
• Minimal harmonized rules governing securities settlement and settlement discipline
Together with the Regulation on OTC derivatives (EMIR) and the Markets in Financial Instruments
Directive (MIFID), it will form a framework in which systemically important securities infrastructures
(trading venues, central counterparties, trade repositories and central securities depositories) are
subject to common rules and settlement discipline measures on a European level. The new
development of the Regulation is: the obligation of dematerialization for most securities, harmonized
settlement periods for most transactions.
• Rules on the authorization, supervision and passporting of CSDs
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Issuers will be able to issue securities in any EU domiciled CSD of their choice. Any buyer or seller of
securities safe kept within an EU CSD, as well CSD participants, will be subject to the settlement
provisions, including a settlement cycle of 2 days (already in force). CSDs will be subject to minimum
requirements and will benefit from a harmonized authorization, supervision and governance regime,
allowing them to passport activities throughout the EU.
In order to reduce settlement risks due to the insolvency of the settlement agent, a CSD should settle
the cash leg of the securities transaction through accounts opened with a central bank, otherwise, a
CSD should be able to settle through accounts opened with a credit institution.
CSDs should be subject to strict record-keeping requirements, they should maintain for at least 10
years all the records and data on all the services that they may provide, including transaction data on
collateral management services that involve the processing of securities repurchase or lending
agreements.
• Conditions under which CSDs may provide banking services
According to Directive 2013/36/EU, CSDs, like other credit institutions, as they provide banking
services ancillary to settlement, should also be subject to enhanced credit and liquidity risk
mitigation requirements, including a risk-based capital surcharge for intra-day credit and liquidity
risks. CSDs should have in place recovery plans to ensure continuity of their critical operations.
Without prejudice to Directive 2014/59/EU of the European Parliament and of the Council (11), the
competent authorities should ensure that an adequate resolution plan is established and maintained
for each CSD in accordance with the relevant national law. CSDs should be authorized to provide
services ancillary to their core services that contribute to enhancing the safety, efficiency and
transparency of the securities markets and that do not create undue risks to their core services.
Namely, such entities must hold a fully-fledged banking license but may provide only limited services.
• Cash penalties. All players will be submitted to settlement discipline with harmonization of
mandatory buy-in rules and penalties based on failed settlements. Another set of rules are
addressing settlement fails and introduce uniform rules concerning penalties and certain
aspects of the buy-in transaction for all transferable securities, money-market instruments,
units in collective investment undertakings and emission allowances, such as timing and
pricing.
• CSDs will be subject to common requirements and uniform conditions for links and access
between CSDs. The development of links agreements between CSDs, in the absence of
common prudential rules, CSDs were importing the risks encountered by CSDs from other
member states. CSD links introduce significant risks for settlement, and they should be
subject to authorization and increased supervision by the relevant competent authorities.
The CSDR dismantle the significant obstacles in the functioning of the internal market, to avoid
distortions of competition by introducing some crucial changes in the functioning of CSDs in T2S. It
introduces an open internal market in securities settlement that should allow any investor in the
Union to invest in all Union securities with the same ease as in, domestic securities. This will enable
the competition between CSDs and should provide the market participants with a greater choice of
providers and reduce reliance on any one infrastructure provider. Any authorized CSDs should enjoy
the freedom to provide services within the territory of the Union, including through setting up a
branch in a host member state, the access should be granted on fair, reasonable and non-
discriminatory terms, and could be refused only where it threatens or causes systemic risk.
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2.4.2. EMIR
The crisis highlighted that the level of counterparty credit risk related to OTC derivatives is very high.
The OTC derivatives are privately negotiated contracts and any information concerning any one of
them is usually only available to the contracting parties. In order to decrease the level of risk on OTC
derivatives market, on 4 July 2012, the Regulation on OTC Derivatives, Central Counterparties and
Trade Repositories was adopted, known as "EMIR"-European Market Infrastructure Regulation. EMIR
introduces:
• Mandatory clearing and reporting for OTC derivative contracts, implementation of strong
measures to improve transparency and regulatory oversight of OTC derivative. Information on
the risks inherent in derivatives markets will be centrally stored and easily accessible to ESMA,
the relevant competent authorities, the European Systemic Risk Board (ESRB) and the relevant
central banks of the ESCB, and will give policy makers and supervisors a clear overview of what is
going on in the markets.
• Standard derivative contracts to be cleared through Central Counterparties (CCPs), as well as
margins for uncleared trades and establishes stringent organizational, business conduct and
prudential requirements for these CCPs. G20 leaders agreed that all standardized OTC derivative
contracts should be cleared through a central counterparty (CCP) by the end of 2012.
2.5. THE GIOVANNINI BARRIERS
Several researchers analysed the roots of the inefficiencies in the cross-border settlement in EU. The
most significant contribution to this subject is the report issued by the Giovannini Group, that
identifies 15 barriers to an efficient pan-European market infrastructure and makes
recommendations for removing them. Overall, North American exchanges are the most cost and
revenue efficient, followed by European exchanges, while the ones in South American and Asia-
Pacific regions appear to be lagging behind. Giovannini (2002) demonstrated that the presence of
different systems and standards generated communication and synchronization problems, impeding
efficiency and safety for cross-border transactions, that compared to the streamlined domestic
systems was substantially more expensive, less efficient and less safe. As soon as cross-border
settlement gets a little bit complicated, transactions could take up to 5-6 days, and can require the
use of eleven intermediaries at its highest, while a domestic transaction requires only five. As a
consequence of the barriers the cost of settlement of cross-border securities transactions was about
11 times higher. This referred essentially to the costs of settling in the two major International CSDs
(ICSD), Euroclear Bank and Clearstream Banking, situated in Brussels and Luxembourg. The
fragmented system could be compared to an old age when countries couldn’t agree on the width of
the rail track, and the goods should be unload at the borders, bringing new costs. The custody
landscape of Europe, with different technical systems, opening hours, settlement cycles, and
operated under different legislative frameworks, according to the Commission was not “a level
playing field”. The removal of these inefficiencies is a necessary condition for the development of a
large and efficient financial infrastructure in Europe. Without it the entire process of financial market
integration will be suboptimal. The report was generated by analysing a questionnaire of a total of 38
responses, received from institutions involved in all stages of the clearing and security settlement
process and operating from various Member States. The bulk of respondents came from the banking
33
sector, 13 commercial banks and 12 investment banks, also from 6 national, CSDs, both of the ICSDs,
4 stock exchanges and an association of investment managers.
Barrier 1: National differences in information technology and interfaces
This is the most frequently cited barrier, by 30 of 38 respondents. National clearing and settlement
systems operate on a variety of unstandardized platforms. These implied differences in information
technology and interfaces add to the cost of cross-border clearing and settlement by requiring a
higher level of manual input. Additional cost arises because institutions must invest in understanding
the technologies concerned and in multiple back-office interfaces to communicate with all necessary
systems, with a need for additional staff to understand and support the various arrangements.
Barrier 2: National clearing and settlement restrictions that require the use of multiple systems.
National restrictions on the location of clearing and settlement typically require investors to use the
national system. This requires investors, who engage in cross-border securities transactions on
multiple stock exchanges, to use multiple post-trading systems. National restrictions on the location
of clearing and settlement prevent cross-border investors from centralizing their activities. These
restrictions seem outdated in the context of efforts to integrate the EU financial system, and their
removal, together with the creation of bridges between national systems.
Barrier 3: Differences in national rules relating to corporate actions (the offering of share options,
rights issues), beneficial ownership and custody. As corporate actions often require a response from
the securities owner, national differences in how they are managed may require specialized local
knowledge and the lodgement of physical documents locally, and so inhibit the centralization of
securities settlement and custody.
Barrier 4: Absence of intra-day settlement finality. Intra-day settlement finality is needed to ensure
that pan-EU clearing and settlement can be delivered efficiently, while minimizing systemic risk.
Before T2S, intra-day settlement finality cannot be guaranteed for all cross-border transactions
within the EU. Settlement cycle timing differences between platforms tend to impede same-day
transfer between systems. If same-day transfer or finality cannot be achieved, there is a requirement
for the counterparties to provide extra collateral or incur funding costs.
34
Image 8 EU Fragmented Market Infrastructure. Source: ECB
Barrier 5: Practical impediments to remote access to national clearing and settlement systems
As market participants are required to interface with multiple post-trading systems in the context of
cross-border transactions, there is a resultant duplication of costs. Remote access, the possibility for
an institution to become a member of a system located in another Member State, is both legally and
technically possible. However, practical impediments often remove it as an option.
Barrier 6: National differences in settlement periods. Cross-border clearing and settlement is
complicated by national differences in settlement periods and the need to make adjustments as
settlement periods change. Europe is marked by numerous differences in settlement periods13. The
international consensus favours a short settlement period to limit credit risk. In order to a
harmonized settlement period for the EU as a whole, CSDR mandates the adoption of T+2 for all
transactions in “transferable securities”14. On 15 May 2014, debt managers of all 28 EU Member
States agreed to the implementation of T+2 as the standard settlement period for OTC secondary
market transactions in EU Member State government securities, effective as of 6 October 2014.
Barrier 7: National differences in operating hours/settlement deadlines
Differences in the operating hours of national systems complicates cross-border settlement, if at
least one of the systems concerned does not operate real-time settlement or frequent batches.
13 See annex 14 including exchange traded funds and warrants) that are executed on trading venues (exchanges,
Multilateral Trading Facilities (MTFs) or Organized Trading Facilities (OTFs)) and that are settled in the international or domestic CSDs.
35
Settlement periods should be harmonized across the EU, so as to reduce the need for costly funding
arrangements in cross system transactions. The differences in operating hours can result in the
incompatibility of deadlines for matching and delivery in the different systems. In addition,
inconsistency between the deadlines/opening hours of payment systems and deadlines/opening
hours of securities settlement systems can cause problems in the use of CSDs links.
Barrier 8: National differences in securities issuance practice. The clearing and settlement of cross-
border securities trades is hampered by national differences in issuance, and uneven capability
across the securities markets in Europe to allocate ISIN15numbers to securities issues in real-time.
Barrier 9: National restrictions on the location of securities. The national restrictions often apply to
the location of securities. Such restrictions can limit the choices for issuers when placing their
securities. There are two types of restrictions, first, that listed securities must be deposited
exclusively in the local settlement system, second, there may be a connection between listing on the
regulated market and registration with a local registrar. This can constrain the choice of settlement
location available to users because the selection of a foreign settlement system will be less
attractive.
Barrier 10: National restrictions on the activity of primary dealers and market makers
Restrictions on the activity of primary dealers and market-makers often require the setting-up of
local securities operations and the settlement of primary-market transactions in the local settlement
systems. Such restrictions prevent primary dealers and market-makers whose activities span several
markets from centralizing their settlements in fewer systems. The inability to centralize cross-border
settlements raises the cost of their operations.
Barrier 11: Domestic withholding tax regulations serving to disadvantage foreign intermediaries
Withholding tax relief can be granted in two ways: relief may be provided at source, with a reduced
rate or exemption applied directly to the tax payment made. Relief may also be granted by refunding
the excess withholding tax on the basis of a reclaim by the investor. The clear preference of investors
is for at-source relief, which is offered by the withholding agent (normally a bank or other financial
institution). The majority of Member States restricts withholding responsibilities to entities
established within their own jurisdiction and thereby disadvantages foreign intermediaries in their
capacity to offer at-source relief. Even in those Member States, which allow foreign entities to
assume withholding tax collection obligations, a local fiscal representative must be appointed to
discharge the foreign entity’s withholding obligations. The need to use a local agent or to appoint a
local representative in the discharge of withholding obligations represents a significant extra cost for
foreign intermediaries relative to local providers.
Barrier 12: Transaction taxes collected through functionality integrated into a local settlement
system. The national tax authorities are not always focused on the needs of foreign investors. Tax
15 The ISIN standard is used worldwide to identify specific securities such as bonds, stocks (common and
preferred), futures, warrant, rights, trusts, commercial paper and options. ISINs are assigned to securities to facilitate unambiguous clearing and settlement procedures. They are composed of a 12-digit alphanumeric code and act to unify different ticker symbols “which can vary by exchange and currency” for the same security. (https://www.isin.org/isin/)
36
procedures can be complex and raise interpretation questions. Taxation of securities transactions
can be a barrier to efficient cross-border clearing and settlement. In these circumstances, the foreign
investor's choice of provider for securities settlement is reduced, because it is necessary to link up
with the local settlement system that operates the tax collection functionality. Often, language
problems and a lack of orientation to the needs of the foreign-based taxpayer complicate
communication between foreign intermediaries and the domestic tax authorities. A fundamental
difficulty in the granting of tax relief to the investor is the absence of a standard legal definition of
beneficial owner for specific transaction types.
Besides the taxation barriers, the Giovannini Report identifies 3 legal barriers that relate to cross-
border clearing and settlement. “The law has yet to catch up, it fails to keep pace with developments
in market practice.”
Barrier 13: The absence of an EU-wide framework for the treatment of interests in securities
According to the current practices, it co-locates securities with the systems through which they are
settled. EU Member States have different concepts of property and ownership, often disguised by
the use of expressions such as ‘proprietary rights’ and ‘rights in rem’. The absence of an EU-wide
framework for the treatment of interests in securities (including procedures for the creation,
perfection and enforcement of security) has been identified as the most important source of legal
risk in cross-border transactions.
Barrier 14: National differences in the legal treatment of bilateral netting for financial transactions
Barrier 15: Uneven application of national conflict of law rules. Since almost all transactions involve
some cross-border elements, and therefore it should be examined the laws of more than one
jurisdiction in order to identify the relevant one, and the extent to which each legal system
recognizes the validity of the laws of the other. Some EU legal systems treat as different the
ownership of a security outright and an entitlement (against a settlement system or intermediary) to
own such a security. The market-led convergence in technical requirements and market practice for
clearing and settlement could deliver considerable benefits within a significantly shorter timeframe
than that required for full system mergers. In order to achieve technical convergence could be used
user agreements and market conventions. Whereas, the national authorities should concentrate on
removing the other barriers in the fields of taxation and legal certainty.
2.5.1. The UCITS V Directive
Adopted on 21st of March 2016, it revises the depositary regime as regards depositary eligibility,
duties, responsibilities and liabilities, and defines the conditions in which safekeeping duties can be
delegated. It focuses heavily on increasing investor protection for UCITS investment funds, given that
these are sold to the general public. UCITS or “undertakings for the collective investment in
transferable securities” are investment funds regulated at European Union level. They account for
around 75% of all collective investments by small investors in Europe. UCITS can be set up as a single
fund or as an umbrella fund consisting of multiple compartments, each with a different investment
policy. Key changes compared to UCITS IV are: the introduction of stricter criteria for entities allowed
acting as a depositary (now restricted to credit institutions, national central banks and other legal
entities authorized under the laws of EU Member States to carry out depositaries activities and
37
subject to harmonized additional conditions under UCITS V). Under its scope are asset managers of
UCITS funds, UCITS depositaries. UCITS V will also create a strict depositary liability regime, in case
UCITS’ assets held in custody are lost, investors have the rights of action against the depositaries,
allowing them to sue depositaries. UCITS V puts in place remuneration policies and procedures
designed to prevent conflicts of interest and discourage risk-taking inconsistent with the risk profile
of the managed UCITS. Also, it introduces rules governing remuneration policies of UCITS managers
and put in force the minimum administrative sanctions regime across member states. Such
coordination facilitates the removal of the restrictions on the free movement of units of UCITS in the
Community, and the actual National laws governing collective investment undertakings should be
coordinated with the conditions of competition between those undertakings at Community level.
Luxembourg has successfully positioned itself as the global leader for cross-border distribution of
investment funds, with the result that today more than 65% of UCITS funds distributed
internationally are based in Luxembourg. For the funds industry to adopt T2S as a preferred channel
for settlement means a lot of benefits in terms of infrastructure issues.
Single Entry
Point
The introduction of T2S should create the ability to settle all EUR denominated cross -
border fund transactions placed via any CSD’s in Europe from one settlement account
Access To a CSD and an account at the central bank to settle via T2S, and should not be
overly restrictive whether directly possible or via an intermediary agent. Without
adequate choice, the cost of doing so may well outweigh the benefits
Transparency
of holdings
Cross-border distribution is based on open architecture with Distributors sales
networks selling Promoters funds in exchange for remuneration in the form of fee
rebates. It is essential that Distributors positions in shares are clearly identifiable.
Issuer CSD Industry best practice for eligible securities is to keep the totality of an issue within
the so-called Issuer CSD. Cross - border funds must have the option to maintain the
whole of the shares in issue with the Funds Transfer Agent
CSD Data
Exchange
a legal framework or equivalent facility is required to allow the exchange of data
between CSD’s and the Funds agents to allow the identification of holders to the
level of the contracting party (Distributor) for the calculation of rebates
CSD
reporting-
interfaces
Reporting tools will be needed to allow the exchange of data between the various
CSD’s and the Funds agent. This is required for the identification of Distributors and
organizations purchasing funds via CSD’s for AML\KYC purposes and for the
calculation of fees based on holdings.
Global
Distribution
The share of assets held by investors domiciled outside of Europe is growing and
approaching 50%. Therefore, T2S should facilitate Distributors domiciled outside of
the EEA to settle in T2S.
Alternative
Funds
The trading and settlement methods on T2S should be developed to accommodate
alternative fund types that do not follow a standard equity model of trading and
settlement.
Table 3 T2S Impact for Fund Industry
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2.5.2. MIFID
Markets in Financial Instruments Directive (Directive 2004/39/EC) aims to improve the
competitiveness of EU financial markets, by creating a single market for investment services and
activities, and ensuring a high degree of harmonized investor protection. Following MIFID1 (2004),
MIFID2 (2014) was dramatically widened in scope. It creates greater market transparency, and
strengthens the protection of investors. They include harmonized rules on the authorization and
supervision of investment firms, an EU-passport regime for investments firms, rules on the conduct
of business, on investor protection, and the functioning of the trading platforms. The new trading
obligations for equities and derivatives are intended to restrict the OTC trading, which will impact
price formation and market liquidity. BCNs (Brokers Crossing Networks) and other OTC dark pools
will have to convert to MTFs (Multilateral Trading Facilities), OTFs (Organized Trading Facilities) or SIs
(Systemic Internalizers). The scope of reportable transactions to national authorities is significantly
extended also including derivatives. Also, MIFID2 brings new regulation for algorithm or automated
trades, it will be required to continuously post executable quotes during the trading day, and they
will need to become authorized to ensure that excessive orders cannot seize up markets or increase
volatility; this means the delivery of an annual description of trading strategies to competent
authorities, regulators on at least an annual basis about how their strategies work.
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3. METHODOLOGY
For the realisation of this thesis, considering the complexity of the subject, several research methods
were applied. The main incentives for choosing the methodology were: the actuality of the subject,
the limited sources of veritable information related to the project, and the absence of the previous
research background on this matter. Considering this, the method of research was divided into the
following main steps: documentation with the subject, the project implementation plan, through the
ECB website and other official references. In the second phase, the main effort was focused on
gathering the information through different sources, regarding the impact and benefits of itself,
surveys performed by other companies or other scientific researches. On the next stage of the work,
a more practical approach was applied. It was performed a calculation exercise, with data from
European CSDs, to prove or not the existence of a cost benefit. Following this, a field visit was done
to INTERBOLSA headquarter in Porto, where planned interviews were performed.
The detailed description of the performed steps will be documented in the below section.
The methodology for documenting about the T2S project plan, its phases and technical specifications
consists of the analysis of the official documents, discussions, user guides available on the European
Central Bank official website16. They were consulted regularly during all the project duration, in order
to stay up-to-date with the novelty of the last implementations, and to follow the waves of
migrations of all the participants countries. This information is delivered in the Literature Review
section, about: settlement chain, market participants, risks in the settlement chain, also about T2S
implementation, project 5 waves, T2S innovations and migration activities and 19 principles of it.
Also, in this work stage, the T2S Regulatory Framework was presented. The main European
Legislations guiding this initiative and influencing the modern financial environment are CSDR, EMIR,
MiFID and UCITS V. All the documentation regarding them was consulted on European Commission
website17 in the Securities Markets and Post-Trade services section.
Another source of information is the Giovannini Group Reports. This represents the base
documentation regarding the European settlement barriers and the different domestic trading
arrangements. Those arguments represented the trigger for the European Commission to initiate the
T2S Program, in order to dismantle the barriers exposed in the reports, and to harmonise the post-
trade infrastructure. The Giovannini Group was a group of financial market experts, formed in 1996
to advise the European Commission on financial market issues. In particular, the work of the
Giovannini group focused on identifying inefficiencies in EU financial markets and proposing practical
solutions to improve market integration.
In the following part, in order to outline the overall benefits of T2S for different market participants,
the following surveys were consulted: the official European Central Bank reports on the T2S benefits,
delivered in the Special Series: “T2S benefits, much more than fee reduction”; “T2S Economic Impact
Analysis” by The International Capital Market Association ICMA, Sponsored by The European Repo
Council (ERC), another survey conducted by BNP Paribas in May 2016: “T2S Industry Survey – you
might be surprised”, and Accenture survey on international banks, held in April 2016: “Evolution or
16 https://www.ecb.europa.eu/paym/t2s/html/index.en.html 17 https://ec.europa.eu/info
40
overhaul? How banks are adapting to TARGET2-Securities in Europe”. It was performed a
comprehensive analysis of them, and afterwards, it was highlighted the 6 main benefits concluded
between all the respondents of the surveys.
In the succesive part, it was conducted a cost benefits analysis of settlement fees, before and after
T2S implementation, using the calculation model presented in Giovannini Group Report (2002)
OXERA study (2011), and a more recent calculation performed during this dissertation (2011-2015).
As a reference model, it will be used the Giovannini Model (First Giovannini Report (2002)). His paper
stresses on the importance of the removal of cost inefficiencies in clearing and settlement, as a
necessary condition for the development of an efficient financial infrastructure in Europe. He
developed 2 methods for estimating the additional cost of settling a cross-border transaction. First,
he chose the comparison of settlement fees, an obvious approach in assessing the relative cost of
cross-border and domestic transactions. But he identified several limitations of this approach, apart
from the problem of data availability: there is neither a “typical” fee, nor a “typical” service in
processing a domestic or cross-border securities transaction. According to Giovannini: “the fee
structure of providers tends to be highly complex, with the fee actually paid by clients dependent on
a wide range of factors. These factors include the type of securities to be processed, the type of
client, the volume of business of that client, the client’s method of payment, relationship with the
provider (e.g. share in ownership of the CSD). Meanwhile, the settlement service provided varies
with the provider. Some CSDs provide only the narrow settlement functionality, while others offer a
range of ancillary services, such as intra-day credit and securities lending. A simple comparison of the
fee schedules for settling a domestic and cross-border transaction is, therefore, likely to yield a
misleading view of the relative costs.”
An alternative approach focuses on the operating income per transaction settled. This approach for
estimating the cost of settlement services is more indirect and sophisticated. Giovannini used the
data on the operating income obtained from the financial statements of the relevant service
providers, as well as ICSDs. The approach followed is much centred to standardize the implicit costs
of settlement across CSDs, in this manner, the formula for operating income per transaction settled
is reduced, and such components as interest income, items of depreciation and amortization and
exceptional costs have been removed.
The second study, we refer to, is the Oxera Study, a price monitoring study commissioned by DG
Internal Market and Services of the European Commission, that examines the impact of recent
changes in the industry on the costs of trading and post-trading services. It provides an analysis of a
new large set of data collected by Oxera from intermediaries (40 fund managers, 40 brokerage firms
and 60 custodians), and infrastructure providers (trading platforms, CCP, CSDs) operating in the
trading and post-trading value chain in 18 financial European centres. Commission classified them in
3 types of financial centre: major (France, Germany, Italy, Spain, Switzerland and UK), secondary
(Belgium, Luxembourg, the Netherlands, Norway, Poland, Sweden), and other (Austria, Czech
Republic, Denmark, Greece, Ireland and Portugal). The study measured the effect of market
integration on prices of trading and post-trading services over the period 2006-2009, capturing the
development of MIFID.
Limits of the study as mentioned by Oxera:
41
-other types of costs are not included, as access and membership fees, or interest that broker may
receive on cash margins when using CCP.
-there is no standard definition of the core services provided by the intermediaries or infrastructure
providers.
-the main issue when analysing these data is the non-disclosure agreement and restrictions on data
availability. The results are presented aggregated and in absolute terms across the financial centres.
Usually the brokers and CSDs are global firms, pressured by competition factor, and it is difficult to
break their data. This study can be undertaken only if the firms provide sufficient data on their use of
channels and the cost of trading and post-trading services on a consistent basis.
In my study, it was applied the same approach as OXERA and Giovannini, for identification of the
average differences between the settlement costs of cross border and domestic transactions, over a
more recent period, 2011-2015. Rather than comparing the pricing schedule, this study, as the
Giovannini study, applies the method of measuring the actual unit cost of the trading and post-
trading services on the basis of the revenues (divided by the number or value of transaction). It
provides the comparison of the prices of transactions, between domestics and cross border ones,
over the mentioned above period. The data processed in this study was collected from annual
reports of the settlement institutions, issues of the European Central Bank, and information from the
settlement institutions and statistic databases. The methodology for analysing the economic impact
of T2S presented in this note proposes some indicators for evaluating the potential benefits of T2S
for market participants and the European economy. One of the indicators is the total average fee per
settlement instruction. The aim of this indicator is to focus on a direct comparison between the cost
per settlement instruction with T2S, and the current market structure without T2S. The data
processed belongs to 2 ICSDs (Euroclear Bank, Clearstream Banking Luxembourg), and 13 national
CSDs, between them ECSD Eesti Väärtpaberikeskus, Clearstream Banking AG, Bank of Greece
Securities Settlement System (BOGS), Iberclear - BME Group, Monte Titoli S.p.A., Latvijas Centrālais
depozitārijs, Lietuvos centrinis vertybinių popierių depozitoriumas, VipLux, Malta Stock Exchange,
OeKB CSD GmbH, Interbolsa, KDD, Centrálny depozitár cenných papierov SR, Euroclear Finland, SC
Depozitarul Central SA, VP Securities A/S, Euroclear France, Euroclear Netherlands, Euroclear
Belgium. The same as mentioned by Oxera study, the major limitation of the referred study is the
unavailability of recent data, and some CSDs were excluded, because of data unavailability for the
mentioned period.
The next step was the field visit to INTERBOLSA Portugal, organised after several discussions with the
board of INTERBOLSA from Porto. It was held on 21 of August 2017.
INTERBOLSA - Sociedade Gestora de Sistemas de Liquidação e de Sistemas Centralizados de Valores
Mobiliários, S.A. (hereinafter INTERBOLSA) is a limited liability company, which purpose is the
management of securities settlement systems and central securities depository systems. During this
visit, the planned interviews were done with the management team, in order to get the required
information about the T2S benefits for INTERBOLSA, and about its functioning since the migration to
the new settlement platform in March 2016 (the questions discussed in the interview presented in
annex). The answers to be revealed in the results part.
42
4. RESULTS
After analysing the surveys, several benefits for the industry participants were identified, showing
the viability and cost efficiency of the T2S project. Per International Capital Market Association ICMA,
62% of respondent banks see T2S as a way to reduce cash accounts and funding complexity;
respondents felt that T2S will have most significant impact regarding: collateral pooling, increased
liquidity, and a decrease in the number of agent banks.
In March and April 2016, Accenture undertook a survey between 20 international banks regarding
T2S, focusing on their strategy and readiness and understanding of benefits brought by T2S. A large
majority (90 percent) of respondents have a T2S readiness strategy in place and began working on its
implementation. The top areas most positively affected by T2S are: liquidity management,
settlement processing and collateral management. The third survey on this topic was conducted by
BNP Paribas between 50 leaders (May, 2016). When asked, what will be the greatest benefit with T2S
fully implemented, the answers were divided between: collateral and liquidity management - 25%,
cost savings - 15%, new functionalities - 21%, harmonization- 39%.
Competition and business benefits
The T2S implementation and the new European legislation on CSDs, will introduce important changes
for the European settlement landscape. The CSDs operate in a largely monopolistic national
environment. T2S, together with the new legislation, will push them for competition, as it will help
remove many of the technical and market practice restrictions. The market participants will benefit
from a much greater freedom of choice regarding where they trade, clear and settle. Also, issuers will
have the choice of which CSD of issuance to use to settle securities issued in another CSD, legally.
They will have access to deeper markets to raise funds, and will no need to consider issuance in
multiple countries. T2S represents the European single railway tracks of settlement industry. This will
stimulate the CSDs to move up the value chain, also to compete for the customers that have now
more freedom of choice and possibilities.
Collateral and liquidity savings
T2S is creating nowadays a single gateway to collateral management. This is one of the most
important benefits for the banks and other sell-side institution. Before T2S, in the post financial
crises environment, due to increased regulation the collateral requirements raised high in quality and
quantity. In a fragmented infrastructure, investors with a diversified portfolio have to hold their
securities through custodians with different national CSDs. This creates inefficiencies for collateral
and liquidity management, because of the need to keep multiple cash accounts as collateral and
pledged in multiple NCBs. They need to keep sufficient buffers of collateral for every market they
operate in. This is because the liquidity for those securities lies within those CSDs. That makes cross-
CSD settlement, involving an investor holding his securities with a single CSD, which then acts as an
“investor CSD” in other markets, inefficient and costly. Secondly, the access to ECB money is
performed via each NCB, meaning connection needed to many domestic markets. Also, the
fragmentation of collateral inventory creates operational overheads securities among international
CSDs and global custodians, the amounts are limited and settlement can only take place in
commercial bank money, not central bank money. As a result, banks usually need to hold significant
43
excess collateral, because they cannot reuse surplus collateral and liquidity if they have a long
position in a settlement system. At the same time, they need to maintain a precautionary buffer of
collateral and liquidity for days when they will be short in this market. T2S brings significant changes
for collateral management. It will make it possible for banks to have a single buffer for the entirety of
their European business, a single pool of assets and liquidity that will automatically generate
significant collateral savings. Banks and intermediaries will be able to manage their collateral much
more efficiently, optimize their funding costs and avoid failed deliveries. Before T2S, the cross-border
management of collateral was always associated with additional costs, due to the additional time lag
in moving collateral from one securities account to another, but also the differences in time
schedules and operating hours among CSDs. These delays significantly impede the quick cross-border
movement of collateral, resulting in collateral being left unused. T2S creates a borderless settlement
scheme and CSDs will use a common settlement time schedule and optimization mechanisms,
ensuring easier collateral mobilization, real-time cross-border settlement and the immediate re-use
of collateral on a cross-border basis.
Possibility to Auto Collateralization
Auto-collateralization is a new key feature for many T2S participants’ markets. It is a way to obtain
liquidity in order to support securities settlement. This pooling of cash and collateral will lead to
major liquidity savings. It is a credit operation that is triggered automatically during settlement, in
case a buyer doesn’t have sufficient funds to settle a securities transaction as to improve its cash
position; he can use the very same securities that are being bought, as collateral, to obtain the
central bank intraday credit needed to pay for the purchased securities (called auto collateralization
on flow), or the securities that are already being held by the buyer (auto collateralization on stock).
This auto-collateralization feature in T2S will significantly reduce the need for pre-funding of cash
accounts, both for daytime settlement and, in particular, for night-time settlement. Value of
collateral savings generated by T2S, so far, exceed 50 EUR million per year. In conclusion, T2S will
overcome market fragmentation by creating a single collateral and liquidity pool. T2S Users will be
able to centralize liquidity in a single central bank cash account, and manage collateral optimizing
their funding costs, as T2S eliminates the need to hold excess collateral in different European
national markets. Additionally, T2S will reduce collateral settlement needs by having a single engine
and extend auto-collateralization to all CSDs.
Operational efficiency benefits
One of the key sources of efficiency for custodians, is the reduction in back office costs and the
reduction of operational risk. 71% of operations staff see positive sides in T2S, meaning expectations
of a simplification of work, reduction in fails and accounts, less post-settlement date chasings. Before
T2S, custodians had to maintain separate back offices, adapting to the various local settlement
procedures, to interact with each CSD, or even employ a local sub-custodian to carry out the task on
their behalf. The T2S technical platform brings a high degree of harmonization in the securities
settlement process. It will make it much easier for custodians to consolidate these separate back
offices into a central back office and achieve a very high degree of automation. The T2S information
security will comply with the highest industry standards. It will have an extremely robust business
continuity solution, with the operational standards that are already applied in the TARGET2 system.
44
The financial impact of T2S will result in annual back office cost savings of 48 EUR million per year
(per ECB’s Economic Impact Assessment, published in 2008).
Safety benefits
As T2S was developed in a financial crisis circumstances, it was modelled to bring safety benefits for
the European financial market.T2S will reduce counterparty risk and risk on the settlement agent,
because it will only settle in central bank money - the safest settlement asset. Settlement in
commercial bank money is always subject to the risk that the settlement agent may fail. On a macro
level, T2S will reduce systemic risk by having a highly efficient settlement engine, with gross real-time
settlement finality in central bank money even for cross-border transactions. Before the majority of
cross-border transactions were settled in commercial bank money and were exposed to safety
concerns. T2S will improve the efficiency of cross-border transaction, by offering direct connectivity
to banks, diminishing the number of possible “weak links” in the chain. Nevertheless, T2S allows
settlement for participants outside T2S markets, but only in commercial bank money.
Following these surveys, it is noticeable that the expectations and benefits are perceived differently
for each segment of players of the financial market. T2S will transform fundamentally the traditional
post-trade landscape, and will diminish the traditional distinctive lines between banks, local and
global custodians, CSDs. Market players will need to adapt to enter new terrain down the value chain
to gain competitive advantage. T2S users net benefits are: collateral savings, optimization of their
funding costs and less failed deliveries, benefits from increased competition between CSDs, ICSDs,
agent banks, benefits from accelerated process of harmonization and standardization. Generally, the
respondents are very optimistic regarding T2S and 48% of them see clear improvement on post-trade
in Europe. In terms of pricing, overall the respondents are expecting the prices charged for
settlement to decrease quite significantly, while prices charged for asset servicing and connectivity
are expected to rise. T2S will have significant implications for the sub-custodians. Smaller regional
players that normally act as sub-custodians for global custodians must rethink their business models.
T2S will put pressure on revenues from settlement services, as it will assume much of the Eurozone’s
settlement activity. Thus, CSDs must develop new services and possibly tap into the services
traditionally offered by local custodians. For CSDs, T2S offers the possibility to reshape their existing
settlement infrastructure into a more optimal model. This reshaping will allow cost savings relative to
their current investment, as CSDs will be able to recover these costs (including their profit margin)
from their users, by charging T2S fees.
The interview to INTERBOLSA originated the following answers, that present the official INTERBOLSA
point of view about T2S. A great achievement of T2S is the harmonization in what concerns matching
rules, settlement cycles and corporate actions processing, and all the functionalities and
optimizations of T2S had a positive impact increasing settlement efficiency. T2S and CSD Regulation
(CSDR) brought big changes in the post trade industry. Per INTERBOLSA, the main challenges were
huge technical adaptations for the connection to T2S platform and the conversion of debt
instruments from quantity to face amount with pool factor. INTERBOLSA participants were very
interested on the benefits that T2S would bring on cross border transactions. It provides both direct
and indirect connectivity to T2S. If a participant uses the indirect connectivity he can choose between
ISO15022 messages via SWIFT and the proprietary interface provided by INTERBOLSA. All 3 options
are being used by participants. INTERBOLSA intends to establish direct links with ESES CSDs, NBB SSS,
45
Clearstream, Iberclear and Monte Titoli. Regarding costs, INTERBOLSA stated that there were no
savings but adaptation costs, as it had in place a settlement system before joining T2S. Nevertheless,
the initial period for cost recovery defined by ECB in 2010 was 8,75 years. If we look just for the
settlement we can say that the cost decreased, but if the total cost is considered, it is higher due to
the communication costs. Also, INTERBOLSA sees no problem in separating the platform that
provides settlement services (T2S) form the custody and other services that will remain to be
provided by the CSDs.
The results of the analysis of the cost benefit of T2S are presented in the following part. The report of
Giovannini and Oxera prove that the cross-border transactions are more expensive than the
domestic one. The analysis conducted in this study come to the same results. According to
Giovannini, the settlement fees of the ICSDs are considerably more expensive than those of the
national CSDs. For example, the settlement fee of an equity transaction of the Danish CSD is between
0,11-0,28 EUR, while the average fee of Euroclear for settling an international equity transaction is
much higher, up to 32,47 EUR.
National CSDs Equity Bonds
Denmark 0,11-2,28
Germany 0,25-0,40 0,125-5,00
France 0,30-1,13 0,30-1,13
Italy 0,72
UK 0,32-0,90
Switzerland 0,26
Table 4 Settlement fees of a sample of national CSDs, in euro
46
CSD Internal External
International
securities
Domestic
securities
International
securities
Domestic securities
Equity Bond Equity Bond Equity Bond Equity Bond
Clearstream
LU
2.00 1.35 2.00 1.35 -- -- -- --
Euroclear
Bank
2.71 1.35 2.71 1.35
SIS -- -- 32.47 32.47 27.60-
48.70
21.65-27.06
DE 2.16 2.16 32.47 32.47 21.65 21.65
FR -- -- 32.47 32.47 13.53-
27.06
13.53-27.06
UK -- -- 32.47 32.47 10.82 10.82
US -- -- 32.47 32.47 5.41 10.82
Table 5 Settlement fees of Clearstream for selected markets, in euro
CSD Internal External
International
securities
Domestic securities International
securities
Domestic securities
Equity Bond Equity Bond Equity Bond Equity Bond
Clearstream
LU
-- -- 1.03-2.71 1.03-2.71 -- --
Euroclear
Bank
0.49-
2.16
0.49-2.16 -- -- -- -- -- --
SIS 0.60-2.71 0.60-2.71 9.74-
16.23
5.94-
10.80
DE 0.32-1.73 0.32-1.73 4.33-8.66 1.52-6.49
FR 0.60-2.71 0.60-2.71 -- -- 23.81-
32.47
7.58-
21.65
UK 0.54-2.16 0.54-2.16 -- -- 6.49-
10.82
9.74-
16.23
US 0.54-2.16 0.54-2.16 -- -- 4.33-8.66 6.49-
10.82
47
Table 6 Settlement fees of Euroclear for selected markets, in euro
The comparability of the data is limited by the absence of a typical settlement fee and a typical
settlement service. The average value of a transaction, measured in terms of costs, is composed by:
78% of trading and post-trading costs that relate to infrastructure, trading platforms, 19% by CCPs
and 4% to CSDs clearing and settlement cost. It is not an easy task to give a precise formula of
clearing and settlement, as it is composed of many elements and the contribution of each to the
total varies from CSD to CSD. This also makes it difficult to lead out an objective analysis of the
causes of high all-in costs for trading and to distinguish settlement from custody fees. The
distribution of fees between the different activities (trading, clearing, settlement) varies
considerably, by trader and by exchange in function of a series of factors, the individual user’s trading
profile: wholesale or retail trades, as shown in the image 9.
Image 9 The Distribution of fees between activities
Clearing and settlement represents only one part of the full cost to the broker or investor. Besides
the fixed fees, it contains other components as back-office costs such as those for connection and
communication, monitoring, reconciliation, collateral, fiscal, legal, billing, relationship management
etc. Also, the total all-in cost trade is impacted by the user profile at a given exchange, certain
profiles incur significantly higher unit costs than others.
Giovannini alternative approach focuses on the operating income per transaction settled. It reveals a
big difference between the ICSDs operating income per transaction comparing to the national CSDs,
while the Euroclear bank manage to get 32.78 EUR per transaction, the Danish CSD is getting 3.99
EUR.
48
Organization Operating
income (EUR)
Transactions OPINC/trans
action
ICSD Euroclear Bank 360,590,000 11,000,000 32.78
ICSD Clearstream Luxembourg 401,175,000 12,000,000 33.43
DK VP 27,122,013 6,800,000 3.99
DE Clearstream Frankfurt 268,746,000 125,000,000 2.15
ES SCLV 45,758,000 11,000,000 4.16
GR CSD 47,805,161 21,973,933 2.18
FR Euroclear France 144,968,647 135,000,000 1.07
IT Monte Titoli 22,175,332 126,395,972 0.18
PT INTERBOLSA 14,205,395 8,654,761 1.64
SE VPC 43,125,089 14,633,242 2.95
UK CREST 143,446,634 58,816,750 2.44
EU EU 1,644,565,272 531,874,658 2.86
EU (excl. ICSDs) 882,800,272 508,874,658 1,49
ICSD SIS 103,231,065 17,745,900 5.82
Table 7 Operating income per transaction (in euro)
The Oxera study provides the comparison of the prices between domestics and cross border
transactions, over the period 2006-2009. In this period the number of trades has doubled, reaching
904,150,671, also the average trade size of a transaction in equities felt from 35036 EUR in 2006 to
10522 EUR in 2009.
49
Table 8 Evolution of volumes of trades between 2006 2009. Source Oxera Analysis
This reduction is due to the increased competition between financial centres, entering of new
players, and an increase in the scale of transactions. CSDs reported also a reduction in their core
services prices. The cost of service is composed by asset servicing cost and clearing and settlement
cost. Table 9 shows a reduction of 9% over 2006-09 for account provision and asset servicing for
equities, from 0.19 EUR to 0.17 EUR. While the clearing and settlement cost per transaction was
reduced from 0.62 EUR to 0.46 EUR over the same period.
Table 9 Cost of services provided by CSDs, equities and fixed income securities
The same as the Giovannini report, the Oxera study shows that cross border transactions tend to be
more expensive than domestic ones, for both safekeeping and settlement. The fixed income and
equities cost changes will be presented separately in the following part. The prices for clearing and
settlement for equities transactions have come down in most cases, the differences between the
costs of domestic and cross border transactions is significant. The ratio got smaller over the period,
from 480 % in 2006 to 330% in 2009. In absolute terms, the changes in relative costs of cross border
and clearing settlement services for equities dropped from 1.83 EUR comparing to 0.39 EUR in 2006,
and 0.9 to 0.27 EUR in 2009 (table 10).
Table 10 Changes in the relative costs of clearing and settlement services-equities
50
The fixed income cost changes are illustrated in table 11, it shows a big difference between cross
border transaction (4 EUR), comparing to 0.42 for a domestic one in 2006, to 1.68 EUR for cross
border and 0.30 for a domestic transaction in 2009.
Table 11 Changes in the relative costs of clearing and settlement services-fixed income securities
Total changes for securities are calculated as an average between the equities and fixed income
(table 12). In 2006, the cost per cross border transaction was 2.34, while a domestic one was 0.57
EUR. In 2009, the cost per cross border transaction diminished by 44 % to 0.96 EUR, the domestic
transactions reduced by 32% to 0.36 EUR.
Table 12 Changes in the relative costs of cross border clearing and settlement services- total securities.
After analysing the OXERA report, it can be concluded that the general trend is the decrease in unit
cost per transaction, either for equity or fixed income transactions across all financial centres. While
the differences between the domestic and cross-border transactions remain a problem, in most
cases the prices for clearing and settlement have come down, while the difference between the costs
for domestic and cross-border transaction have increased. In 2009 the crossborder transaction
represents 260% of the national one (table 12).
Table 13 Comparison between costs of cross border and domestic CSDs services, total securities.
51
The same calculation model was applied for the period 2011-2015 on a sample of CSDs participants
at T2S, amd it revealed significant differences in the volumes of transactions, number of particants in
the European CSDs analysed, and the operating income.
The ICSDS mark a significant growth in the value of securities held on accounts, Euroclear Bank leading with 11240151 million EUR, average value of securities held on accounts.
As in the previous 2 studies, we notice an increase in the number of participants, at the ICSDs,
Euroclear in 2015, riches 1602, Clearstream Banking Luxembourg with 1421, while the maximum
between the national CSDs is represented by Germany with 288, considerably less participants than
the ICSDs.
Figure 2 The Average Number of Participants in CSDS 2015
The same tren is noticed regaurding the average number of transactions. The chart below illustrates the discrepancies between the ICSDs and the national ones (Euroclear and Clearstream, both leading
Figure 1 Average value of securities held on accounts with central securities depositories (EUR millions)
52
with 70860.8 and 22744.8 thousands transactions processed). While several CSDs do not pass 100 thousands transactions, as Malta with 250000, Latvia-41000.
The comparability of data was limited by the absence of data from several CSDs, following several
attempts to obtain information directly form their offices via emails. Also, it was jeopardize by the
different interpetation of data for CSDs, for example the number of transactions can be presented
with netting and no netting, when a sell-buy transaction is considered as 1, or 2 separate
transactions. Also it was influenced by the exchange rate, as some CSDs present their operating
income in the annual financial report in the local currency.
Figure 3 The average number of transactions processed 2011-2015
53
5. CONCLUSION
Objective 1: the main objective is to evaluate the T2S impact on the new harmonized European
securities market landscape and also to assess its direct contribution to the reduction of settlement
costs in Europe. we target to understand the benefits T2S brings on the table for the market
participants, in particular through the case of Interbolsa Portugal.
It was concluded that T2S brings a range of benefits for the market participants, though it was
finished recently, in September 2017. The main benefits are competition and business benefits,
collateral and liquidity savings, possibility to auto collateralization, operational efficiency benefits,
safety benefits. Through the case of Portuguese CDS, INTERBOLSA, it was concluded that all the
functionalities and optimizations of T2S had a positive impact increasing settlement efficiency,
diminishing the settlement risks and operational risk.
Obejctive 2: this research aims to describe the risks associated with the post-trade activity, the
technical inefficiencies among settlement industry in Europe, with different domestic arrangements,
that T2S is addressing. This objective relates to identifying the technical, legal and tax barriers in the
post-trade environment.
During this master thesis, it was identified that the main risks jeopardizing an investor are: the
settlement risk, counterparty risk, operational risks, credit risks and liquidity risks. The main threats
for an investor are: that securities are delivered but no cash received, or vice versa, because of a
default of a counterparty or intermediary; the possibility that either one of the counterparties may
fail to meet their obligations. It was concluded that the cross border transactions are more
complicated and risky, than the domestic ones. In addition to the risks mentioned, the trade’s
international aspects rises the level of operational and credit risk, also legal risk, which contains an
unexpected intervention of a foreign law, or regulation, that makes the contract enforceable. The
customer also faces foreign exchange risk, when the trade is done between two currencies.
T2S has a significant impact on the creation of a new harmonized European securities market
landscape, contibuting to reduction of the number of intermediaries involved in a cros border
transaction. Also, it eliminates the technical barriers described by Giovannini in the First Report, and
make the settlement flow smoother and faster.
Objective 3: to prove that there is existent a real harmonization of costs between European CSDs,
and also that there are cost savings per unit price of a settlement transaction, at the national and
cross border level.
As we see in the previous chapter, T2S brings many welfare implications for the participants, indeed
the cost reduction is an important achievement, conceived as a driver for the further financial
harmonization. After the analysing the 3 numerical cases, it was concluded that T2S has a direct
contribution to the reduction of settlement costs in Europe. INTERBOLSA Portugal stated that if we
look just for the settlement we can say that the cost decreased, but if the total cost is considered it is
higher due to the communication costs. The transaction cost savings is represented by the difference
between the average fee charged by settlement service providers (CSDs or custodian banks) for core
settlement services today and the total average fee per settlement instruction with T2S. The new T2S
54
pricing shows the tariffs established by the ECB for the post-trading settlement across all European
CSDs. The standard DVP instruction fee is 0.15 EUR, compared to a rough European average of 0.40-
0.50 EUR with CSDs before T2S.
Tariff items Price Explanation
Delivery versus payment 15
cents
per instruction
Free of payment/payment free of delivery 9
cents
per instruction
Internal T2S liquidity transfer 9
cents
per transfer
Account allocation 3
cents
per instruction
Matching 3
cents
per instruction
Intra-position/intra-balance movement 6
cents
per transaction
Auto-collateralization service with payment
bank
15
cents
for issue and return, charged to collateral
provider
Intended settlement day failed transaction 15
cents
surcharge per business day failed per
instruction
Daytime settlement process 3
cents
additional surcharge per instruction
Daytime-last two hours, 2pm-4pm Free per transaction, charged to the collateral
provider
Auto-collateralization service with national
central bank
Free surcharge per instruction
Instruction marked with “top/high priority” Free per instruction
Cancellation Free per instruction
Settlement modification Free
Information services
A2A reports 0.4
cent
per business item in a report
A2A queries 0.7
cent
per queried business item
U2A queries 10
cents
per executed query
Message bundled into a file 0.4
cent
per message in each file containing
bundled messages
Transmissions 1.2
cent
per transmission
Account management services
Securities account Free
Fee per cash account Free Monthly
55
Table 14 T2S ECB Pricelist
The T2S invoicing circuit functions as following: the CSD is charged by T2S (T2S fees), the CSD will
charge the custodian (T2S fees +CSD mark-up fee); the direct connectivity participant is also charged
by the network provider. The final client will be charged by the custodian fees (T2S+CSD+
connectivity + Custodian fee). This price is fixed for the period from 22 June 2015, if the following
conditions are fulfilled:
• non-euro currencies add at least 20% to the euro settlement volume
• the securities settlement volume in the EU is not more than 10% lower than the volumes
projected by the T2S Programme Office, which in turn are based on market advice
• tax authorities confirm that the Eurosystem will not be charged VAT for T2S services
(approved)
T2S Programme Board, after several assessments on costs and pricing, spent 256.4 EUR million for
the development of T2S, and 50.7 EUR million on average per year during the running phase on the
side of the four central banks which will develop the T2S business application and operate T2S
(Deutsche Bundesbank, Banco de España, Banque de France, and Banca d’Italia - jointly referred to as
the “4CB”). The costs on the side of the ECB, which supports the T2S Programme Board and
coordinates the relations with internal and external stakeholders, are expected to amount to 90.2
EUR million over the development phase and 9.3 EUR million on average per year during the running
phase. In addition, the T2S Programme Board currently calculates interest costs for the financing of
T2S of 67.5 EUR million and a contingency provision of 36 EUR million to cover costs related to the
maintenance of the system, minor changes, and potential liability claims. The cost-benefit analysis
conducted together with market participants in 2008 revealed that less than half of the expected
annual T2S benefits would be generated from savings on CSD settlement fees, with the rest arising
from the streamlining of back-office functions and collateral savings at the user level.
In my opinion, the reduction in settlement cost is an important achievement for European Financial
Market, nevertheless as mentioned by INTERBOLSA, the additional communication costs make the
total fees higher. Also, this standard DVP fee is non- guaranteed in case any of the conditions above
aren´t fulfilled. This project is affected by a series of political and other external factors, that could
impact the future evolution of the project, it´s financing and the overall cost. As an example, Great
Britain, the largest single securities market in Europe, opt OUT of this ambitious project. Its non-
involvement in T2S made it more expensive to implement. On the other side, UK potentially loses out
on the benefit of any future reductions in settlement costs. This topic could be a reference for the
future studies related to the relationship between the EU political organization and the financial
market and T2S. At the end it’s all about investing in joining!
.
56
6. LIMITATIONS AND RECOMMENDATIONS FOR FUTURE WORKS
During this master thesis there were identified several limitations. The availability of CSDs data from
annual reports was a problem, as several CSDs don´t present it on their website, and refused to
disclose it after being directly contacted. This led to dissmising some CSDs from the research and may
impact the numerical case study. Many CSDs consider the financial information, settlement prices,
costs, a strictly confidencial information, as it is able to influence competition and the market.
This study was performed during the T2S project implementation, this means that many of the
results/benefits/ expectations are perceived by the market participants on a considerably short
period of time, the final phase of the project ended recently, in September 2017.
This can be a recommendation for the future study, to test the T2S project impact, benefits and
other effects, in a larger timeframe, at least after 5 year of implementation, when the project will
reach “its maturity”. Also the cost benefits analysis should be reviewed annualy, as the maintanance
costs and running costs of the project can vary, depending on several factors, including the structure
and number of participants.
In my opinion, this is a major project for the financial infrastructure of the European Union, and it will
bring many effects on the settlement process and the whole market functioning, and they will be
more obvious in a larger timeframe.
57
7. BIBLIOGRAPHY
Author, A. A., Author, B. B., & Author, C. C. (Year). Title of article. Title of Periodical, volume number
(issue number), pages.
“Financial Statements of KDD – Central Securities Clearing Corporation (KDD).” KDD, Feb. 2015,
wwwen.kdd.si/_files/1224/4_Financial%20statements_%20december%2031%202014.pdf.
ECB. “T2S - a Single Gateway for Your Collateral Management.” YouTube, 16 Sept. 2013,
www.youtube.com/watch?v=dbyma82l-rQ.
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8. ANNEX
INTERBOLSA questionnaire on T2S migration
One of the biggest benefits of the T2S is the possibility to pool liquidity for settlement in the T2S zone
via a single central bank money cash account, what other benefits are perceived as major for the
CSDs, from the INTERBOLSA perspective?
Do you agree that CSDs migration to T2S is the start of post trade transformation? Which were the
main challenges for INTERBOLSA to adapt this transformation, both in terms of technical and
organizational changes?
T2S aims at increasing efficiency and reduce risks by facilitating centralized securities settlement at a
European scale. After INTERBOLSA migration to T2S, did you perceive any major reductions of risks
and liability risk?
T2S will have several functionalities and improvements not available in the Portuguese market, as
prioritization, partial settlement, auto collateralization, linked instructions, securities blocking,
reservation, earmarking. What is the importance of such a development for INTERBOLSA?
One of the T2S objectives is to facilitate cross border settlement. To accomplish this goal there must
be interoperability between CSDs. Which are the main CSDs INTERBOLSA should have
interoperability with: Euroclear, Clearstream, Iberclear? Which other mutual links INTERBOLSA is
planning to establish?
Which is the type of connectivity to T2S direct or indirect provided by the INTERBOLSA interface to
its clients?
What are the incentives/disincentives for INTERBOLSA to join T2S?
What is the amortization period of the settlement platform currently used by CSD?
How should T2S affect the links among CSDs of the EURO area? And outside euro area?
Do you see any problem in separating the platform that provides settlement services (T2S) form the
custody and other services that will remain to be provided by the CSDs?
What would be the cost savings for INTERBOLSA in joining T2S and not having to develop a
settlement platform itself?
In terms of INTERBOLSA Pricelist, how does T2S impacted the settlement costs?
62